Line of Credit: Online Lenders vs. Traditional Banks

Lines of credit are preset loan limit that are offered by banks and other various alternative lenders. This type of credit is available for use at any time. With a line of credit or LOC, the borrower can “withdraw” money out until you get to the set limit. The limit replenishes as the money is repaid, allowing you to borrow again as needed.

A line of credit is an arrangement between a bank, alternative lender, or any financial institution and a customer or the borrower. They establish a maximum amount of loan in which the customer can borrow. This fund is available for access by the borrower at any time, given that they only get what is agreed upon. Moreover, the borrower should also meet the requirements set by the lender and payments must be made in a timely manner.

How Lines of Credit Work

All lines of credit has a set amount that is available for borrowing as needed. The loan is paid back and the line of credit is replenished and will be available to be borrowed again. The lender sets the interest rates, payment terms, and other rules. Some lenders allow you to create drafts or write checks, while the others make the funds available through debit or credit card. Lines of credit are available with security or otherwise, but take note that unsecured LOCs have higher interest rates.

Lines of credit are generally flexible; this is one of its advantages. You, the borrower, can borrow a certain amount of money, but you are not required to use or spend it all. You can tailor spending according to your needs and interest is only added to the amount of money taken and not on the amount of the entire credit line. Moreover, you can adjust repayment amounts accordingly depending on your cash flow or budget. Borrowers can repay all outstanding balances at once or choose to make monthly payments. We recommend that you read the following article to learn how you can qualify for a line of credit?

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Unsecured Vs Secured Lines of Credit

Most of the time, lines of credit are not secured, which means you, the borrower, does not back the loan with any collateral. Nonetheless, there is one exception. The HELOC or home equity line of credit is secured by the home equity of the borrower. This is the most common type of secured LOC, which many lenders find attractive since they have a backup in case the borrower is not able to repay the loan.

Most business owners prefer secured lines of credit because these offer comparatively higher credit limit than unsecured ones. Secured LOC also has lower interest rates.

Unsecured LOC, on the other hand, comes with higher interest rates and they are more difficult to get, as well. With unsecured line of credit, lenders usually require the borrower to meet their credit score requirement, which can be impossible for some individuals and business owners. Since they are unsecured, lenders are more likely to limit the amount of funds. Technically, credit cards can be considered unsecured line of credit.

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Revocable Line of Credit

A revocable line of credit is a credit source that a traditional bank or financial institution provides to a business or individual. This line of credit can be annulled or revoked under specific circumstances. The line of credit can be revoked in case the customer’s financial standing deteriorates or if the market situation is extremely bad. A revocable LOC can either be secured or unsecured.

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Revolving Vs. Non-Revolving LOC

Most of the time, a line of credit is considered as a revolving account or an open-end credit. With this arrangement, the borrower is allowed to withdraw the money, repay the amount borrowed and then use the funds again. This is almost a never-ending cycle.

Non-revolving lines of credit, on the other hand, have almost similar features as the revolving line of credit. However, there is one exception. Once you have borrowed and repaid the money, the available credit is not replenished. The credit account will be closed once the credit is fully paid.

There are two features of both kinds of lines of credit that make them particularly attractive: purchase flexibility and payment flexibility.

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Different Examples of Lines of Credit

Lines of credit come in various forms, and each form falls under either the secured or unsecured category.

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Personal Line of Credit

This is a type of unsecured line of credit that has funds available for borrowing again and again, as long as you are repaying what you have used. In order to open a personal line of credit, the borrower must have a high credit score, preferably 680 and up and has a reliable source of income. It is an advantage to have a personal savings and you will get a higher chance of getting a LOC if you offer a collateral in stock form, although this is not really necessary. Mostly, personal lines of credit are used for personal matters, such as emergencies, travel, entertainment, weddings, important events, or to help ease the borrower out from a financial situation.

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HELOC

HELOCs or Home Equity Lines of Credit are a type of secured LOC, which is secured by the borrower’s home market value. Typically, HELOC credit limit averages to 75% of the property’s market value, minus the mortgage balance.

HELOCs usually come with a 10-year draw period, during which, you, the borrower can be able to access any available funds, repay and then access them again. Once the draw period ended, the loan can be extended or the balance will be due. This type of line of credit generally has closing costs, which included the appraisal cost of the property that is used as collateral.

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Demand Line of Credit

This type of LOC is not very popular. It can be backed by a collateral or not, but with this line of credit, the lender can set the due at any time. Depending on the LOC terms, payback can either be interest plus principal or interest-only. Like most line of credit, the borrower can use the maximum credit amount at any given time.

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SBLOC or Securities-Backed Line of Credit

This type of LOC is backed by the borrower’s securities. Generally, an SBLOC lender allows the borrower to get up to 95% of its assets’ value. These are non-purpose loans and cannot be used to buy and trade securities, but any other type of expenses is allowed.

With SBLOCs, the borrower is required to make interest-only payments every month until the loan is fully paid.

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Business Line of Credit

This type of LOC is often used by businesses to get an as-needed funding versus getting a fixed loan. Lenders that offer business lines of credit evaluate the borrower’s profitability, market value, and possible risks, extending the LOC according to their evaluation. Business lines of credit can either be secured or unsecured, but this basically depends on the size of loan requested and the results of the evaluation. You can use the line of credit to acquire equipment for your business. Like other types of lines of credit, interest rates may vary.

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Lines of Credit Limitations

As discussed earlier, the main benefit of a line of credit is that the borrower can get only the amount they need and avoid paying larger interest that comes with a big loan. With that being said, you must also take note of the potential problems involved in getting a line of credit:

  • Unsecured lines of credit have higher interest rates than secured ones.
  • Unsecured lines of credits have more credit requirements than secured LOCs.
  • With lines of credit, do not expect the same regulatory protection as what you are getting from credit cards. Going over the credit limit and late payments might result in surprising penalties.
  • You might be tempted to overspend because your credit line is open.
  • Misuse of LOC can have a negative impact on your credit score.
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Traditional Banks vs. Alternative Lenders: The Pros and Cons

Various types of alternative lenders are sprouting and disrupting the model of traditional banks. Back then, you can only get financing through banks, but with the hundreds, if not thousands, of online alternative lenders offering an easier way to get a loan, things have changed. However, although the latter is considered easier and simpler, both models have their advantages and disadvantages.

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Bank Loan: Advantages and Disadvantages:

Banks are still the most popular go-to place when it comes to small business loans. Many of those applying for alternative loans are actually people or businesses who could not get a bank loan. One of the reasons for this is that they still can get the best interest rates from banks compared to alternative online lenders. The main benefit of having a loan from a traditional bank is the low interest rates. In addition, the term lengths are also longer.

The disadvantages of bank loans include the tedious approval process, which involves not only a lengthy amount of time, but also an incredible amount of documents. Getting the right documents can even take a lot of time and then once you have submitted them, you also have to wait on the bank’s approval. Waiting time can even last for a few months, but do not expect to get a yes after you’ve waited this long. Banks are notorious for turning down a lot of loan applications.

Another drawback is that banks usually require to put a collateral as a security. Not to mention the bank loans also has prepayment penalties and many other fees even before the loan is processed.

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Online Lenders Advantages and Disadvantages

These days, there is an alternative lending option that suits every type of business. One of the best advantages of getting a loan from these lenders is flexibility. With lines of credit form online lenders, you get to customize according to your financial situation and capacity to pay. You also don’t have to have very high credit score. As a matter of fact, some online lenders do not care if your credit score is that bad, as long as you can show a stable annual revenue.

Furthermore, the application process is very easy and can be done online. You can find out almost instantly if you are qualified for the loan or not, saving you a lot of time and allowing you to apply to another firm in case you get rejected. Approval is quick, as well, and once the application gets approved, you will see money in your account in no time.

These are some of the things that make online lenders seem very inviting, especially to businesses and individuals that do not want to experience the stress involved with applying for a bank loan.

Online lenders are great for businesses with bad credit and also for those who do not want to put a collateral for their loans. Apart from not requiring you to have a high credit score, alternative lenders also ask for fewer documents and they do not ask for a high annual revenue as well. Additionally, you can borrow low cash figures from alternative lenders, while banks mostly only deal with big loan amounts. Your business credit scores have a major impact on your ability to get funding. Once you have started to build your credit score, it will be much easier for you to obtain a business line of credit and other types loans.

The main disadvantage of alternative lenders include higher interest rates and shorter term lengths. Most of the time, repaying your loan from them won’t make your credit score budge up even for a little bit. And since alternative lenders offer short-term loans, there can be some implications in terms of taxes.

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Lines of Credit: Conclusion

With both online lenders and banks having distinct benefits and drawbacks, the decision often lies on the type of business and the person getting the loan. If you are a small business that is operating for more than 3 years, has a good credit standing and a steady revenue, then a bank loan is a great option. Since you have these qualities, your loan is more likely to get approved.

However, for many people, the flexibility, ease of application, and access to instant finance that alternative online lenders offer is quite irresistible. Online lenders are ideal for small businesses and startups alike, and those who want to have access to funds that they can use to grow their business. In addition, since they mostly require no collateral, it can be quite appealing.

In the end, the decision is all yours. So, weigh the pros and cons, check out the options, and choose the best offer that you can get.

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