What Is a Line Of Credit | How To Make a Line Of Credit

A line of credit is a bank authorization that allows a business to access funds without making a loan or going overdrawn. Lines of credit are a way to meet occasional expenses. Among them, we find an exceptional need for cash, the purchase of short-term stock, the completion of work or even the one-time purchase of equipment.

What Is a Line Of Credit
What Is a Line Of Credit

A line of credit, what is it?

A line of credit is the provision of funds by a bank. More precisely, the operation consists in authorizing a customer to use money that he does not have, up to a certain limit and for a given time.

In reality, it is a type of borrowing. It is therefore subject to interest rates.

What is this bank authorization used for?

The advantage of this operation is that it allows a  company, or even an individual, to access funds without having to make a loan or request an overdraft authorization. Thus, lines of credit are most often used to meet unusual expenses.

Businesses use it the most. They generally use it to cover their short-term cash flow needs.

What are the different types of credit lines?

There are several types of lines of credit. First, the classic line of credit. The latter covers occasional expenses. One thinks, for example, of an urgent need for cash to deal with a customer's late payment.

Next, the operating line of credit. These are funds mobilized for the proper functioning of the activity of a company, that is to say its operation. It can then be a question of buying stocks or carrying out work, for example.

Finally, the investment line of credit. Very often, it is used to buy equipment that will be used in the long term.

How to make a line of credit?

To make a line of credit, you have to make a contract. This specifies the amount of the authorized line of credit as well as its duration. It also defines the interest rate that applies.

Generally, the bank authorizes these operations for a few months. However, in the case of investment credit lines, it is customary to revise this duration upwards. It can then go from three to seven years.

In any case, the amount, duration and interest rates of credit lines are always subject to negotiation between the bank and the client company. The conditions of these operations depend on the particular situation of each company. To know the amount that a bank can grant to a company, one can obtain a  recommendation of financial outstanding.

What is the difference between a line of credit and a loan?

A loan is a sum of money that a bank grants to one of its customers. The amount is fixed and the client receives all of it in his account.

A line of credit, on the other hand, is a kind of side bank account that has a certain amount of money. This sum depends on the negotiation between the bank and the customer. Unlike the loan, the amount can change. It can thus be revised upwards or downwards, depending on the client's situation.

In addition, the lines of credit are limited in time. The client will therefore not have access to this money over the long term, as could be the case with a loan.

Nevertheless, in either case, the client will have to pay interest on the sums of money that the bank advances to him.

What is the difference between line of credit and overdraft?

Although similar, line of credit and overdraft are not quite the same thing. Lines of credit are capped accounts that a bank's customers can use over a set period of time to meet one-time expenses.

Overdraft, on the other hand, refers to the situation of a  bank account in deficit. This happens when a customer has spent more money than they originally had. Banks can, however, authorize overdrafts, up to a certain limit. This is called an authorized overdraft.

Like lines of credit, overdrafts often carry interest. In either case, their amount is negotiated with the bank according to each particular case.

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