How Does Short-Term Line of Credit Work?

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Aug 31, 2021Business Loan

Due to a unique situation in the market, Mr. X, who is in the business of running a hotel is experiencing reduced cash flow and finding it difficult to meet the financial obligations to run the business operations efficiently. After a discussion with a friend about the situation in business, he opts for a  short-term line of credit loan. 

Well, if you are wondering what a short-term line of credit is and how it works, then this article is for you.

What is a Short-term Line of Credit?

A line of credit loan is a type of revolving credit for businesses, similar to a credit card, where one gets access to a pool of funds that can be used for meeting both expected and unexpected expenses. The short-term line of credit is usually available for a short duration of six months to one year.

One of the features of a line of credit loan is, the users don’t get access to the funds all at once, but can withdraw a sum from the pool of funds as and when required. The user only needs to pay the interest on the amount used.

A line-of-credit loan is suitable for times like when your business is facing an urgent cash requirement, which you are certain can be repaid in the near short-term.

Features of Short-term Line of Credit Loans

Easy to Qualify for: Compared to any traditional business loan, a line of credit loan has an easy eligibility process and can even be obtained based on financial assets such as fixed deposits, stocks, mutual funds, etc.

It also helps you to build a credit history for your business that will help you to get access to other types of business loans and fundings in the future.

Faster Availability of Funds: A line of credit loan doesn’t involve any heavy paperwork and is approved quickly compared to any other form of traditional business loan, which makes it suitable for businesses looking for quick access to funds.

Must Read: Difference Between Short Term and Long Term Loans

More Control on Usage: A line of credit loan gives you the flexibility to use the loan amount as and when required, and pay interest only on the sum borrowed, There is no restriction from the lender on the usage of funds during the term of the line of credit loan facility.

No Fixed Repayment Schedule: There is no fixed repayment schedule on a line of credit loan. You can repay the borrowed amount depending on your cash flow and earnings, but you need to repay the full borrowed amount before the close of the loan tenure.

Higher Interest Cost: Because of the lenient terms of loans like quick access to funds and no restriction on usage from the lender, a short-term line of credit is higher compared to other business loan interest rates. However, if the loan from your line of credit is secured by financial assets, then the interest rates are far lower.

How to Qualify for a Short-term Line of Credit Loan?

Although the short-term line of credit is a business-friendly financing option, there are some requirements you need to qualify for the loan type:

  • You should have a good credit score / rating
  • Your business should meet the annual turnover requirement prescribed by the lender
  • You need to provide collateral to the lender to secure the loan. This could be any company asset, personal fixed deposits & investment paper etc. For instance, Fullerton India provides loans against securities for small business owners. 
  • Additional business information like nature of business, current debt schedule, financial, tax certificates, business incorporation certificates, etc. 

How Does the Short-term Line of Credit Loan Work?

Suppose, due to restrictive business activity and increased inventory turnaround time, it is resulting in reduced earnings. But there are urgent working capital requirements you need to take care of and there is a shortfall of cash in hand.

Therefore, you decided to go for a ₹5 lakh short-term line of credit loan arrangement with the lender, so that you don’t miss the payments.

In the first instance, you only withdraw ₹2 lakh and not the entire sum. As a result, you will be only obligated to pay interest on the borrowed sum, not on the entire sum, thus being able to avoid a heavy EMI amount.

Must Read: What are the Different Types of Short Term Loans?

Is a Short-term Line of Credit a Right Choice for You?

Indeed, it is a tricky situation for a business owner to decide the right financing option depending on the situation. A short-term line of credit loan is best for meeting all your immediate business requirements.

For example, if you are operating in a seasonal business, where you need high financial leverage to manage the spurt in demand, a short-term line of credit loan is a good option, as you can repay the loan quickly. Also, it can help you on rainy days to keep the business operations running smoothly.

However, you should always stay within the borrowing limits and repay the loan on time.

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