Bank Line

A pre-approved credit arrangement between a borrower (individual or business) and a financial institution, allowing the borrower to access funds up to a specified limit as needed

Author: Andy Yan
Andy Yan
Andy Yan
Investment Banking | Corporate Development

Before deciding to pursue his MBA, Andy previously spent two years at Credit Suisse in Investment Banking, primarily working on M&A and IPO transactions. Prior to joining Credit Suisse, Andy was a Business Analyst Intern for Capital One and worked as an associate for Cambridge Realty Capital Companies.

Andy graduated from University of Chicago with a Bachelor of Arts in Economics and Statistics and is currently an MBA candidate at The University of Chicago Booth School of Business with a concentration in Analytical Finance.

Reviewed By: Josh Pupkin
Josh Pupkin
Josh Pupkin
Private Equity | Investment Banking

Josh has extensive experience private equity, business development, and investment banking. Josh started his career working as an investment banking analyst for Barclays before transitioning to a private equity role Neuberger Berman. Currently, Josh is an Associate in the Strategic Finance Group of Accordion Partners, a management consulting firm which advises on, executes, and implements value creation initiatives and 100 day plans for Private Equity-backed companies and their financial sponsors.

Josh graduated Magna Cum Laude from the University of Maryland, College Park with a Bachelor of Science in Finance and is currently an MBA candidate at Duke University Fuqua School of Business with a concentration in Corporate Strategy.

Last Updated:November 27, 2023

What is a Bank Line?

A Bank Line, also referred to as a line of credit, is a form of loan offered by banks or financial institutions. Unlike traditional loans with fixed terms, a line of credit is more flexible, allowing borrowers, mainly businesses, to access funds as needed and in the way they see fit.

Businesses commonly utilize bank lines to address their capital requirements, finance strategic investments, or fund specific projects. This financial tool involves a pre-approved amount of money that both the customer and the bank agree upon. Once the customer accesses this fund and takes out money, they are required to repay it within a specified period determined by mutual agreement.

Similar to other bank borrowings, a line of credit incurs interest from the moment funds are withdrawn. However, obtaining a line of credit requires approval from the bank, and this approval is based on various factors such as the client's credit rating, credit history, business model, profitability, and past relationships with banks and other credit providers.

It's important to note that this type of borrowing differs from mortgages and car loans. Additionally, a distinctive feature of a line of credit is its revolving nature. This means that after repaying the borrowed amount, the client can access the funds again. However, the interest rates for a line of credit can fluctuate, making it challenging to predict the exact amount owed to the bank at any given time.

Key Takeaways

  • A line of credit is a flexible loan provided by a bank, primarily used by businesses to meet capital needs or fund projects.
  • It involves an approved fund limit, and borrowers can access, use, repay, and reaccess the money, with interest charged upon withdrawal.
  • Three main components define a line of credit: interest rate, borrowing limit, and repayment period, agreed upon in the contract.
  • Different types include Unsecured LOC, Secured LOC, HELOC, Business LOC, Personal LOC, Demand LOC, and Securities-Backed Line of Credit (SBLOC).
  • A bank line is useful for businesses to access ready money for operations, working capital, or financing urgent needs, but misuse or overspending can lead to financial challenges.

How does a line of credit work?

A line of credit involves three main components: 

  • Interest rate
  • The limit to which the client can borrow
  • The time that needs to be repaid.

The two parties need to decide on this when they make the contract. 

There are two important periods during the time in which the credit line is effective: the draw period and the repayment period. 

The draw period is when you can withdraw your money from the fund. The repayment period is when you have to start working on your repayment (principal + interest) to the bank. 

In addition to the money you withdraw, you must make a minimum payment during the draw period, which goes towards your interest or your principal, depending on the agreement or contract. 

During the repayment period, you are given a certain amount of time to pay off your debt to the bank. 

What are the Types of Bank Line?

Some of the types are as follows:

1. Unsecured LOC
This is the most common line of credit since this one does not require any assets to be the collateral to back it. 

This is quite risky for the bank; however, it is easier for the customer to get a line of credit. However, this depends heavily on other factors: credit ratings, credit histories, revenue, expenses, performance, etc.

2. Secured LOC
Most banks usually prefer this type since it guarantees that a large percentage of the money will be repaid. 

LOC of this type is backed by property or other assets. The client can still repay the debt in case of default on loan payments by selling all of the assets that are put on for collateral.

3. Home equity line of credit (HELOC)
This type is backed by the percentage of the asset's potential value created from using the money in the fund. 

HELOC is usually used in construction, where a considerable sum is required for projects like home improvement or real estate development. 

However, this type differs from other types because the client can only withdraw the money at or during a set amount of time. 

4. Business LOC
This one is for those who need money to operate or expand their business. In this case, the performance of the said business is really important. 

The companies may base this on how well the company does to determine whether it is qualified, so that is why collateral is optional. However, the bank might evaluate the balance sheet and take inventory and account receivables as collateral instead. 

5. Personal LOC

This type technically works like a credit card. Therefore, the customer can draw funds anytime as long as it is within the limit. However, a personal LOC does not have a grace period, reward, or charge for cash advances. 

6. Demand LOC

Although rarely used, this kind can be either secured or unsecured. With a demand LOC, the lender has the right to demand repayment at any moment. 

Depending on the LOC's conditions, repayment (up until the loan is called) may be either interest-only or interest + principle. The borrower may use the credit limit at any moment.

7. Securities- Backed Line of Credit ( SBLOC)

This type uses the client’s securities as collateral to qualify for the line. SBLOCs is a non-purpose line of credit, meaning the client can not use the fund to invest in securities or make any trades. Other than that, everything else is allowed. 

SBLOCs ask the borrower to make regular, interest-only payments until the loan is fully repaid or the brokerage or bank demands payment, which may occur if the investor's portfolio value drops below the LOC's ceiling.

What is the Purpose of a Bank Line?

A bank line is one of the fastest ways to access ready money to help finance urgent needs to perform a company’s operations. Besides that, it is also flexible, secure, and beneficial for businesses.

Many businesses try to get a bank line to raise their working capital. This is how companies cope with the funding shortage for projects, events, or expansion plans. 

Another way for a business to utilize a line of credit is to receive cash for works they have done or projects they have executed before their customers pay for them.

Business development and expansion also require immediate cash ready to be spent and invested, which makes the line of credit come in handy.

The problems with lines of credit

Since it works like any loan product, a line of credit can provide endless benefits for those who know how to utilize it. But, unfortunately, it can be disastrous for those who cannot benefit from it and, in some cases, can face potential situations where they have to default on a loan.

However, how interest rates are applied to the line of credit varies from lender to lender depending on various factors such as credit ratings, relationships with the banks, etc. 

Unsecured LOCs have higher interest rates and are more challenging to get approved than those who have secured LOCs since it is way riskier for the banks.

LOCs do not have the same regulatory protection as credit cards and are way stricter regarding late payments. As a result, the lender can see their credit score drop and mark their credit ratings, making it harder for them to lend money in the future.

Misusing or overspending on open LOCs is common, leading to many businesses overspending their budget and defaulting on payment.

Bank Line Credit Vs. other types of Loans 

Let us take a look at the comparison between Bank Line Credit  and other forms of borrowings and lending.

1. Credit cards

Both limit the amount of money you can withdraw. Both have policies and punishments for those who exceed the limit or cannot repay the borrowed money.

However, banks are less likely to approve overages, but they will try to increase the borrowing limit. Both have an annual fee; however, no interest will be applied until the money is drawn.

2. Loans

Loans and lines of credit require acceptable borrowers, and all must be approved. They all have interest rates on any funds borrowed. Using and repaying loans or lines of credit will allow borrowers to increase their credit scores.

Unlike lines of credit, loans have less flexibility since it has a fixed amount for a fixed amount of time and a prearranged payment schedule with a fixed interest rate. On the other hand, lines of credit have fewer restrictions on how the borrower can use the fund. 

A mortgage or an auto loan has to be used to buy a house or car, respectively. However, a borrower can use the money of the fund however they want.

3. Payday and Pawn Loans

There are similarities between these two since the borrowers have to repeatedly borrow, repay or extend their loans with really high fees and interest. However, payday and Pawn Loans also allow almost the same flexibility in how they use the money. 

One big difference between these two is that payday and pawn loans do not have a strict process for approving borrowers and are way less demanding. Therefore, payday and pawn loans cannot offer the same amount of money as a line of credit.

Researched and authored by Huy Phan Linkedin

Reviewed and Edited by Justin Prager-Shulga LinkedIn

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