Financial emergencies may strike anyone at anytime. Unless one has an emergency fund in place to take care of it, the possibility of dipping into one’s investments or borrowing from friends and relatives could be high.
At times, one may even have to purchase consumer goods or meet one’s travel plans but may fall short of funds, unless they had arranged for them earlier.
In all such situations, taking a personal loan or swiping of a credit card comes to mind. While they are a popular option, one may also consider taking a credit line loan, which is somewhat similar to a personal loan and yet has its own differentiating features.
What is a credit line loan and how it differs from personal loan
Also called a line of credit, it has always been available to the self-employed. Ankur Agrawal, Head, Personal Loan & Life Insurance BankBazaar informs, “Most banks and NBFCs provide this kind of credit line loans.” Put simply, in a line of credit, a loan is sanctioned to the borrower on which the interest is payable only on the amount that was withdrawn by the borrower. “Personal loans are a one-time loan. It is disbursed at once in a lump sum. Once a customer takes a personal loan, that credit is exhausted. The credit line, however, takes a different approach. It resembles a credit card in some ways,” informs Agrawal.
In the case of a personal loan, there’s a fixed Equated Monthly Installment (EMI) that has to be paid each month for the pre-determined tenure. But, how will the repayment happen in the case of a credit line? Satyam Kumar, co-founder, Loantap says, “In credit line, one receives an outstanding statement similar to credit card at the end of month and interest accrued has to be paid on or before the due date.” In other words, one has to pay only the interest on the principal amount utilised and not on the principal amount of loan sanctioned. The principal has to be repaid only at the end of the tenure.
In the case of the personal loan, the interest rate is charged on reducing balance but it is not the same in credit line as it works differently. “The interest rate charged in a credit line is flat but the actual interest charged is on the utilization of the credit line,” says Manavjeet Singh, MD & CEO, Rubique, a marketplace lending platform.
How it works
Say, Rs 4 lakh is sanctioned to an individual for 5 years and he withdraws Rs 1.5 lakh, then the interest is charged only on Rs 1.5 lakh. The balance of Rs 2.5 lakh is still available with the borrower to withdraw in instalments or as a lump sum. While the interest is to be paid every month, the principal utilised has to be paid in one lump sum at the end of the tenure or can be paid as part-repayment during the tenure.
Similar to personal loans and credit cards, the credit line loans are also unsecured loans. While a credit card may charge anywhere around 36 percent per annum (around 3 percent on monthly outstanding), a personal or a credit line loan comes at a lower cost. “The range of interest rates is between 10.5% to upwards of 14-15%, depending on the creditworthiness, the profile, etc,” says Agrawal.
Between the two, credit line may come at a higher rate compared to a personal loan. “Although there is no thumb rule behind the current interest rates for both, typically interest rates of credit line based loans are marginally higher than personal loans. Banks and NBFCs have to keep funds blocked anticipating customer withdrawals, this leads to increase in the cost of funds,” says Kumar.
How to decide
If the need for funds is short-term, better to use a credit card and repay entire amount on the due date. Avoid rolling over the outstanding on to the next month by paying the mandatory 5 percent. In rolling over, one not only incurs high-interest rate but also the interest-free period on the new purchases gets lost.
On taking a personal loan after paying the processing fees, it becomes almost mandatory to run it full course i.e. for the entire duration. Although, early termination is allowed any early prepayments or full exit comes at a pre-payment charge of about 2-4 percent of the outstanding amount. if one is sure to not being able to arrange the funds ( equal to the personal loan amount) in the medium term, personal loans may come handy.
The credit line, therefore, may help meet the bill if the need for funds is for a medium duration and one is rather sure of arranging the funds by that time.
If the requirement is for a higher duration, opt for a personal loan or credit line. Consider their costs adjusting for processing and prepayment fees. If the possibility to arrange for the funds is high in the medium term, better to opt for a credit line, based on the costs, else a personal loan could suit the situation. Overall, the total interest outgo could be less if repaid earlier.
Check the processing fees of the credit line loan, in case you are exploring them. The fee would be on the total amount sanctioned and not on the amount that one would withdraw as per the need. Also, read the agreement copy carefully. “Clauses, where the lender can demand repayment of the whole loan at any time, can be there in the agreement”, says Singh.
The lower outflow compared to EMI of a personal loan should not be the reason to get a credit line, the interest outgo, after all, will be higher in them. Credit line could serve you to tide over a financial emergency. But, make sure that you repay the entire withdrawn amount as early as possible. Such loans may help one tide over the bad financial phases in life but once out of it, put a proper plan in place to not to avail them in future. Unless hard pressed for funds, loans of any kind should be one’s last resort as they eat into the returns in one’s investment portfolio.