What is Line of Credit
A line of credit (LOC) or a credit line, is a form of borrowing money that can be used at any time within an agreed limit between the borrower and the lender. The borrower can take out/drawdown money as much as they need as long as they do not exceed the maximum amount (or credit limit) set in the agreement.
How Credit Line Works
All lines of credit consist of a settled amount of money, interest, size of payments and other rules set by the lender. The lender is often a bank or could be another financial institution.
First, the lender would draw down the amount he/she needs. Then, the borrower will need to pay back the amount, along with the interest and processing fees (fees may vary across different lenders). As the money is repaid to the credit line, it can be drawn down again.
In a simpler form, this is how the credit line works:
- Borrower and lender agreed to the amount of credit limit, interest, other fees, minimum monthly payment, and other agreements.
- The borrower can take out the money as much as they need within the credit limit.
- The borrower may repay back the entire outstanding balance at one payment or by paying the minimum monthly payments.
- After paying back, the borrower is eligible to draw down the money again and the same process applies.
Advantages of Credit Line
1. Built-in Flexibility
A credit line is one of the best options if you are looking for flexibility in getting funds. Borrowers will be given a certain amount but they do not have to use everything. Even better, borrowers will only be charged for the amount they use, not the entire amount on the credit line.
2. Adjust Repayment Amounts
As mentioned before, borrowers have the option to pay the entire outstanding balance amount all at once, with other fees charged, or make the minimum monthly payments.
3. Discipline Payments Improve Credit Score
Making repayments on time can help you improve your credit score. A borrower with a better credit score will be eligible for higher credit limit. A higher credit limit will help your business to have funds when sudden expenses arise.
Disadvantages of Credit Line
1. High Penalty for Late Repayments
If you don’t manage to pay back your lender on time, the credit line tends to have high penalty rates. This rate could be charged per day you missed doing the repayment and will be a burden to your financials.
2. Invites overspending
As credit line is often referred to be similar to a credit card, if you are planning to borrow, you must have plans to get more money to pay back. Before applying for a credit line, it is advised to have good cash flow management and know what your spendings are on and how much. A good budget planning is also ideal to prevent overspending.
3. Misuse of Credit Line Affects Credit Score
Late repayments may also affect your credit score in which will burden you in the future if you need to apply for loans or credit cards. To find out more on how you can improve your credit score, check out this article: 4 Easy Ways to Improve Credit Score Fast in Singapore
Different Types of Credit Lines for StartUps
Unsecured vs Secured Credit Line
An unsecured line of credit means that the borrower does not have to promise any collateral to the lender to back the line of credit. This is a preferable method for small businesses that are still young and do not have any assets or collateral.
However, an unsecured line of credit tends to come with higher interest rates as it may be risky for the lenders to give funds without any collateral. For that same reason, an unsecured line of credit is often more difficult to obtain as they require a higher credit score.
On the other hand, a secured line of credit means that the borrower should offer some collateral. For some business owners, a secured line of credit is much more attractive because they typically come with significantly lower interest rates compared to the unsecured line of credit.
In addition, because there are some collaterals to back the line of credit, lenders see less risk in offering a higher maximum credit limit compared to an unsecured line of credit.
Revolving vs Non-revolving Credit Line
A line of credit is generally considered to be a type of revolving account. Meaning, borrowers are allowed to spend the money, make repayment and spend the money again in a revolving cycle.
One thing that differentiates a non-revolving credit line from the typical credit line, is that once you make repayment to the line of credit, the account is closed and money cannot be used again.
Credit Line for Start-Ups
Line of Credit could be the preferable method of getting funds for startups compared to taking out a fixed loan as it promotes flexibility in getting the money anytime and at any amount within the limit. The line of credit may be unsecured or secured depending on the credit evaluation result.
Some tips before applying for credit line:
- Read the terms and conditions in the contract between you and the lender thoroughly.
- Take note of the fees that you will be charged.
- Take note of the dates that you should do the repayment.
We envision a world where business owners have fast and simple access to the funding they need to grow. That’s why we’re on a mission to re-invent banking for SMEs across Southeast Asia.
Our current product provides SME and startup owners in Singapore with financial flexibility through a line of credit of up to S$150k. Which, can also be used to make business payments to enjoy 60 days free credit terms.
With no monthly fees or obligations to withdraw, you only pay interest on the amount you end up using. Opening an account is free and can be done online here.