Line of Credit

A line of credit is a commitment from a lender to pay a company whenever it needs cash, up to a pre-set maximum level.  It is generally secured by company assets, and for that reason bears an interest rate nor for above the prime rate. The bank will typically charge an annual maintenance fee irrespective of the amount of funds drawn down on the loan, on the grounds that it has invested in the competition of paperwork for the loan.  The bank will also likely require an annual audit of key accounts and assets balances to verify that the company’s financial situation is in line with the bank’s assumptions. One problem with a line of credit is that the bank could cancel the line or refuse to allow extra funds to be drawn down from it if the bank feels that the company is no longer a good credit risk.

The line of credit is most useful for situations in which there may be only short-term cash shortfalls or seasonal needs that result in the line being drawn to zero at some point during the year. If one’s cash requirements are expected to be longer term, then a term note or bond is a more appropriate form of financing.

The line of credit is a credit source extended to an individual, business or government by a financial institution or bank. A line of credit might take many forms such as export packing credit, demand loan, overdraft, discounting, purchase of commercial bills, term loan, etc.  It is efficiently a bank account which could readily be tapped at the borrower's discretion. Generally, interest is only paid on cash actually withdrawn. The lines of credit could be unsecured or secured by collateral.

Questionnaire:

• What is line of credit?
• What is the use of the line of credit?