Definition and Examples of a Standby Line of Credit
Consumers and businesses may want to quickly borrow money if they need to, without having to apply for a loan at the time they need it. A standby line of credit makes that possible. Borrowers apply for the line of credit, the lender approves them, and they can wait to draw from the line of credit until a situation comes up when they need the money.
There are many different kinds of standby lines of credit. Sometimes, consumers use credit cards as standby lines of credit. They may apply for a credit card and keep their credit line available for unforeseen expenses. Businesses may also apply for a standby line of credit to access while waiting for invoices to be paid or if they need to cover costs when an unexpected cash shortfall arises.
How Does a Standby Line of Credit Work?
Borrowers who want credit available for emergencies can apply for a standby line of credit. Individuals or businesses can apply with credit card issuers, banks, or other financial institutions. The standby line of credit may be secured (backed by collateral) or unsecured. Lenders evaluate borrower credentials to decide how large of a credit line to approve, then establish a maximum limit the borrower is allowed to access.
Sometimes, the line of credit is revolving. That means the borrower can draw down the credit line by borrowing some or all of the money available. As the borrower repays the amount borrowed, the line of credit becomes available again.
The line of credit may either be available indefinitely, or eligibility may be reviewed periodically, such as once per year. Lines of credit may have annual fees, which means the borrower would pay for the privilege of being able to access the credit line as needed.
The amount of the payments due on the standby line of credit is based on the type of credit line, the interest rate, and the amount drawn. Borrowers will be required to cover interest with their monthly payments, and potentially repay some of the principal as well, depending on how the line of credit is structured.
Alternatives to a Standby Line of Credit
A standby line of credit is an alternative to a term loan or an installment loan. This type of loan results in the borrower receiving a lump sum upon being approved for the loan. The borrower makes fixed payments to repay the amount due, based on the loan repayment timeline, the loan interest rate, and the amount borrowed.
A term loan is less flexible than a standby line of credit, since the borrower receives a set amount of money all at once rather than just being able to access credit if it becomes needed. The borrower also immediately begins to owe interest on the borrowed funds and to make payments.
With a standby line of credit, a borrower has the option to access up to the credit limit, but isn't required to do so all at once or at all. And they don't have to make payments on their standby line of credit unless or until they begin to draw down the cash.
A mortgage loan is an example of a term loan. The borrower receives a set amount of money upfront toward the purchase of a home.
A home equity line of credit (HELOC), on the other hand, could be used as a standby line of credit if a homeowner applied for the HELOC to gain access to a line of credit they could use in the event of an emergency or unexpected expenses.
- A standby line of credit allows individuals or businesses to borrow up to a certain amount of money as needed.
- It could be secured or unsecured; if it is secured, some assets guarantee the loan will be repaid.
- Payments do not become due on a standby line of credit unless or until the borrower accesses money from it.