A Business Encyclopedia

Line of Credit

Definition: The Line of Credit is the agreement between the financial institution (bank) and the individual (company or government) with respect to the maximum loan amount that an individual can borrow from a bank any time he wants, provided the loan amount does not exceed the set limit in the agreement.

In other words, Line of credit is the credit limit of customer, i.e. maximum amount of credit the customer is allowed. The line of Credit can be in the form of a demand loan, term loan, overdraft protection, purchase of commercial bills, etc. The line of credit can be secured by collaterals or could be unsecured depending on the past credit records of the individual.

The advantage of a line of credit over the ordinary loans is that the borrower is required to pay interest on the amount actually borrowed while in the case of ordinary loans the interest is charged on the full amount taken as a loan, irrespective of the actual amount withdrawn by the individual.

Such as, if there is an agreement between the bank and the individual for the maximum credit limit of say Rs 1,00,000, and if the individual withdraws only 20,000, then the interest will be charged on just the withdrawn amount, i.e. Rs 20,000. Whereas, if it had been an ordinary loan, then the interest would have been charged on the full amount i.e. 1,00,000.

The other advantage of a line of credit is that the rate of interest charged on money withdrawn within the limits is less than the interest rate charged on a one-time loan.

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