What is a Line of Credit and How is it Different Than a Loan?

When you make the transition from being a hard-working employee working under a mean manager to becoming a hard-working businessperson, there are no words to describe your joy. You have finally managed to become your own master and get to do things the way you want. You will be getting returns according to the hard work you put in,and there is no ceiling on your growth prospects. You are willing to work extra hours and travel extensively all around, to get more orders and earn more money. All this is very much possible but only if you have the financial resources to keep your business going through various ups and downs.

During the initial period, you can use your own savings and borrowings to get the business venture going,buteventually, you will need access to additional funds as your business grows. In such a situation the most suitable option for you would be to seek financing from any of the various financial institutions in India. The most popular type of funding options offered by financial institutions is either in the form of a Business Loan or line of credit.

What is a Business Loan?

A BusinessLoan is a form of financing product offered by financial institutions to owners of small and medium-sized business ventures. Depending on the amount required and purpose of the loan, it could be secured as well as unsecured. The rates of interest against Business Loans vary from lender to lender. The amount sanctioned as a Business Loan can be used for business-related expenses only,and you are required to inform the lender regarding the final usage of money.

Moreover, you also need to submit a detailed business proposal to the lender regarding the need of the loan and benefits to be accrued from it. The repayment tenure for a Business Loan is usually 60 months but can go up to 84 months, depending on the lender as well as the purpose of the loan. Examples of Business Loans include machinery loan, working capital loan, unsecured loan, and so on.You can use both the online channel and offline channel to Apply for a Business Loan.

What is a Line of Credit?

The line of credit is becoming very popular these days and businesses prefer getting credit facilities through this channel as compared to loans. This facility works on the principle of revolving credit,i.e., a particular amount is sanctioned, which acts as a credit limit, whenever you use some money from the amount the limit is reduced, and whenever you make repayments the limit is restored.

The line of credit is a facility in which the required amount is transferred to another account, from which you can borrow as and when required. You need not pay interest on the entire loan amount but on the amount that has been utilised. The interest is calculated on a daily EOD (End of Day) basis. You need not follow any fixed repayment schedule but only need to pay interest on a monthly basis. The principal can be repaid according to your financial situation, but the limit would be restored only after you make repayment towards the principal. This facility is offered by both banks as well as NBFCs (Non-Banking Financial Companies).

Difference between the line of credit and a loan

The main reason behind the rising popularity of line of credit is the fact that businesses do not use the entire loan amount in one go, it takes them some time to use up the entire loan amount which might extend to several months. So, it hurts their finances when they have to pay interest on the money which is lying in their account and has not been used. The line of credit offers them greater flexibility in terms of use of money and repayments. Here are the major points that differentiate the line of credit from a loan:

  • You need to pay interest only on the amount utilised,and for the duration, it has been utilised,and the interest is calculated on a daily basis in case of a line of credit. There is no need to pay interest on the entire loan amount.
  • There is no fixed repayment schedule to be followed in case of a line of credit. You have to pay interest on a monthly basis and principal repayment as per your finances.
  • There is no particular date on which the line of credit would be closed; it may happen that you are using it even after 5-6 years of first availing it.
  • The amount available is reduced when you withdraw any money and is restored when you make repayment towards the principal component.
  • Your lender can increase or decrease the limit sanctioned to you on a periodic basis depending on your usage and repayment patterns.
  • There are no foreclosure or pre-payment charges against the line of credit.

The line of credit is fast becoming very popular amongst business owners as it helps them meet their liabilities efficiently and does not put any unnecessary interest burden on their finances.

Also Read:Using Loan Against Property to Start Your Business?

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