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Bank Line

A line of credit from a bank or financial institution

What is a bank line?

A “bank line” or a “Line of Credit” (LOC) is a kind of loan that is extended to an individual, corporation, or government entity, by a bank or other financial institution. This type of credit is different from term loans such as housing mortgages and car loans applied for by borrowers. Usually, the borrowers of an LOC can access the funds at any time as long as the agreed credit limit is not exceeded and timely minimum payments are diligently made.

This is also a type of revolving credit account, wherein the borrower can access the money, spend it, repay it, and then access and spend it again. The bank or financial lender will charge interest as soon as money is borrowed, but only on the actual amount of funds accessed, not on the total line of credit. Bank approval for this type of credit depends on the borrower’s credit history, credit rating, and business or personal relationship with the bank.

 

Bank Line - theme

 

What are the types of Bank Line?

Unsecured LOC – there is no collateral backing the loan, but a borrower must establish a good credit rating and status to qualify. Small businesses with proven positive credit histories are more likely to get approved, but the amount of credit extended depends on various factors, such as revenue, expenses, established credit, and years in business.

Secured LOC – property or equity in a property serve as the collateral for this LOC. In case of default on the loan payment, the lender has the ability to recover the money when the property is sold.

Home Equity (HELOC) – typically used for large purchases, such as home improvements and vehicles. The amount of funds that can be borrowed under an HELOC is based on a percentage of the appraised value of the home, less the amount still owed. There is a draw term, which means that funds can only be accessed, taken out, during a set period of time.

Business LOC – extended to clients who operate a business. Collateral is not often required, but banks are stringent on qualifications – some financial institutions accept inventory and accounts receivable to back-up the LOC.

Personal LOC – extended to individuals, who can draw funds any time as long as the credit limit is not exceeded. In contrast to a credit card, this personal line of credit has a lower interest rate, no grace period or reward for early payment, no charge for cash advances, and the balance is transferable between accounts.

 

What is the Purpose of a bank line?

In terms of flexibility and security, a bank line of credit can be helpful for businesses as well as for individuals who are in urgent need of ready cash.  One of the most typical uses of having a line of credit in a financial institution is for working capital. Funds are readily extended to business borrowers for settling obligations while their receivables are still pending collection or waiting to clear. LOCs are often renewable on an annual basis and require accounts receivable, aging on a regular basis.

 

What situations are a bank line useful in?

  • Events or projects with funding challenges, such as weddings, funerals, birthdays, etc.
  • Individuals who are self-employed or work on commission who urgently need cash as the next paycheck is not yet available.
  • Emergency situations, such as taxes, bill payments, health issues, school tuition, etc.
  • Overdraft protection for check users who are often in short supply of cash to fund their drawn checks.
  • Buying or investing in business opportunities, or promoting a business through advertising, marketing, or tradeshow participation.

 

More learning

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CFI’s mission is to help you become a world-class financial analyst. With that goal in mind, these resources will help you on your way:

  • Revolving debt facility
  • Senior and subordinated debt
  • Debt schedule
  • Financial modeling best practices

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