What is a credit line

What is a credit line

A credit line is a product that optimizes the process of obtaining traditional loans. Under this type of lending, funds are provided that a client or organization can use over a specific period and up to a set amount. The borrower is spared the need to submit loan applications every time they need funds – they can draw them at any moment within the established limit. The interest rate applies only to the utilized portion of the amount. 

The utilized part of a credit line is called a tranche. The repayment period depends on the terms of the specific program. The term can reach up to six months, and there is usually no strict payment schedule, allowing the borrower to repay the debt in installments at a convenient time, but no later than the stated deadline. 

Liquid collateral is most often required to open a credit line. In this way, the bank reduces the likelihood of non-performing loans and, in turn, offers the client the most favorable terms. If the borrower is unable to settle their debts, the creditor sells the collateralized property to recover their money. 

In Russian banks, credit lines are most commonly provided only to businesses. For individuals, credit cards with grace periods perform these functions. A credit line itself is rarely offered to an individual. 

Differences between a credit line and a loan

The process of issuing money for a loan and opening a credit line is quite similar. In both cases, the creditor approves a limit, concludes an agreement with the borrower, and then transfers the money to their account. Despite the main similarities, there are also differences, which are shown in the table. 

Types of credit lines

Credit lines provided by Russian banks come in several types. Some of them can be mixed, while others are found only in pure form. Let us examine all existing ones. 

Revolving credit line

According to the terms of a revolving credit line, the borrower can draw funds multiple times, but the available limit will remain unchanged. Money directed toward debt repayment becomes available again until the period specified in the agreement. 

Non-revolving or straight credit line

Under a simple non-revolving credit line, the borrower can receive money in several tranches. This is convenient for paying business needs. After the debt is repaid, the limit is not reinstated; the bank credits incoming payments toward reducing the principal debt and does not provide the option to reuse the funds. Obtaining additional funds is possible after re-applying to open a credit line. This type of credit line is used to finance project tasks, such as purchasing equipment, when the cost of the goods is clearly known and there is a payment schedule. 

Framework credit line

When concluding the agreement, the creditor specifies the purpose of the lending for which the borrowed funds will be used, the loan period, and the conditions for reinstating the credit limit. This type is used to solve regular business tasks. 

Demand credit line

The terms of demand programs are structured such that the borrower receives funds that can only be reused after full repayment of the debt amount. It is precisely this type that may be offered to private individuals. 

Current account type

The current account type implies that the borrower has an active-passive account where business funds are stored and from which borrowed money is disbursed. This type of credit line is used to close cash gaps and is similar to an overdraft. Thanks to a competitive program, a legal entity has the opportunity to make unplanned payments using borrowed amounts and close the debt later, after receiving funds. 

Features of credit lines

The purpose of credit lines can vary. Such a service may be required by large enterprises and private individuals. It can be arranged to finance a major project or replenish the working capital of a commercial firm. Let us understand in which cases a credit line is needed by legal entities and individuals. 

For legal entities

Developing business projects constantly requires investments, so project owners and entrepreneurs often turn to the bank for additional financing. In addition to traditional lending, they may be offered a credit line, which is useful as a backup source of funds. The advantage is that interest rates on credit lines for legal entities are usually minimal – from 10 to 20%, while commissions on certain loan products can reach 60%. 

The corporate lending market features a range of revolving and non-revolving credit lines. Banks are more loyal to such clients since the money is directed into business operations where risks and profitability can be forecasted. 

Credit lines opened for entrepreneurs have certain features: 

1. Determination of the interest rate. Depending on the program, lenders can offer fixed and floating rates tied to the sales plan and changes in the Central Bank's key rate. 
2. Determining the interest rate for each tranche. Credit institutions offer preferential rates for tranches aimed at responsible financing. 
3. Funds may be blocked. This occurs in the event of a breach of contract terms, as well as in cases of misuse. 
4. A regular mandatory payment may be charged to the borrower. This must be specified in the agreement. 

For individuals

Credit cards are freely available to many citizens. The service is widespread and accessible. To obtain a credit line, it is sufficient to submit an application on the website or contact the bank. After reviewing the application, the lender determines the limit, sets a grace period, interest rate, and other terms which may be personalized. After signing the agreement and activating the card, funds can be used subject to certain rules. The key condition is the timely repayment of funds. A credit card is essentially a credit line for individuals. 

Pros and cons

Main advantages of a credit line:

1. Time-saving. The client does not need to submit a new application if the amount needs to be increased. Funds will be available at any time under a single agreement. 
2. Loan amount. The borrower independently determines how much funds they want to draw from the available credit line. 
3. Interest accrual system. Interest is charged only on the amount that the borrower has spent until it is repaid. 
4. Interest rate size. Provided that the main lending conditions are met, the interest rate will be minimal. 

Disadvantages include: 

1. Application review time. To make a decision on opening a credit line for a legal entity, the bank requires sufficient time for verification. A positive response can be regarded as a sign of high trust in the client. 
2. Attention to detail. It is extremely crucial to comply with all terms of the agreement. If any clause is violated, the credit line may be blocked, which can cause serious problems for the business. 
3. Reporting. The legal entity is obliged to timely inform the bank about all changes in its constituent documents. 
4. Penalties for non-use of the credit line. Banks may penalize the borrower if they do not use the open line. This can lead to sanctions from the credit institution and damage your credit history. 

What to choose: a credit line or a loan

The type of lending must be chosen depending on the goals set. A classic loan is applicable for one-time expenses, such as:

• purchase of equipment and furniture;
• themed goods;
• furniture. 

Such loans are suitable when the required amount can be precisely determined at the planning stage. 

A credit line is optimal for small recurring expenses, as well as for projects that periodically require funding. It can be used during repairs, because interest will be charged only on the spent amount. In such cases, it is necessary to choose a credit line with a revolving limit, otherwise you will have to periodically contact the bank to increase it. 

How to open a credit line: a guide

You can apply for opening a credit line on the financial organizations' website or by personally contacting the bank. Following the initial review of the borrower's application, a personal manager will contact them to clarify specific information. The bank reserves the right to request the following details:

• a copy of the business owner's passport; 
• the company's financial statements for the last 6 months; 
• business registration details; 
• collateral security for the credit line (not always required). 

If the bank's employees consider the client creditworthy, a credit line will be opened for their company and the maximum amount available for use will be determined. For regular clients with a good reputation, banks can make personalized proposals that take into account the company's needs and capabilities as much as possible. 

Bank terms and requirements

Credit lines available on the financial market today offer various conditions, including individual ones. The main requirements for opening a CL are: 

• confirmed solvency of the borrower; 
• having an account with the bank that opens the credit line; 
• provision of liquid collateral; 
• the amount of tranches cannot exceed the limits set by the bank. 

A credit line is a rather convenient financial instrument used to accelerate business growth and development. It provides an additional source of funding. It must be understood that the successful use of borrowed funds has a direct impact on shaping relationships with credit institutions. 

Consequently, a credit line is a flexible tool allowing borrowers to save money and time. These resources are fundamental for successful business development.