Debt Dictionary

Line of Credit

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Non-Availability of funds should not deter the growth of a company or discourage an individual to pass on the need to acquire an asset. To address this need, financial organizations like banks often extend a source of credit to its customers, called the Line of Credit.

The line of credit may be a cash credit, an overdraft, a demand loan or a term loan. It is like a contingency, to be used only when needed. The benefit of a line of credit over a regular loan is that interest is not charged on the amount of money that it allows to be withdrawn but on the actual amount withdrawn. A maximum amount that can be withdrawn as loan amount is established at the time of preparing the line of credit between the financial institute and the borrower. The borrower can draw any amount he or she wishes, as long as the limit is not exceeded. The interests are also paid on that amount only.

A cash credit is a kind of line of credit, which allows the customer to borrow cash for a short time. This is particularly useful to owners of small businesses which often face a cash crunch and need such contingencies to tide them over. This requires a certain collateral or security to be deposited to the bank or financial institute by the borrower, against which the loan up to a certain fixed amount can be taken.

An overdraft is usually a term which is used to define an account where amount debited has increased the amount credited and the balance has gone into negatives. An overdraft line of credit can be established between a customer and a bank, where the bank can offer to pay for overdrafts till a certain limit. The bank usually offers this service to trusted and regular customers -often business organizations or wealthy investors. After an agreement of compliance is duly signed, the bank extends a credit on overdrafts, which can be drawn upon in case of need. A small fee for establishing this line of credit is often charged, along with the interest on the credited amount. Interest is not charged for available credit, which reflects in the bank statement of the account holder, along with available balance.

A demand loan is also a type of line of credit which allows the customer a certain amount of cash available for loan, against interest charged for the said amount. This kind of line of credit, gives the financial institution the right to demand back the outstanding loan amount. This line of credit is usually reserved for clients who have been loyal customers of the institution for long and have some kind of credibility that they will pay up. The benefit of this is immense to the borrower as it does not require monthly payments over a period of time. The borrower can plan his incoming fund flow and pay back at his own convenience. The bank too, has the security of demanding for a payback, if it wishes to.

A term loan can also be categorized as a line of credit when a certain amount of cash is made available by the bank to a customer, to be paid back through a time period between a year and ten years. This loan operates on floating interest and can be essentially useful to small businesses which can fall back on it to pay for its monthly expenses for the starting years.

A line of credit is a boon for businesses as well as individuals who do not always have available cash. It is a good business for a financial organization too, bringing profits and building relationships.

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