Credit plays an integral part in the economic progress of a country and an individual; credit helps fulfil goals and aspirations and aids in development. Individuals and businesses require different categories of credit facilities depending on the requirements, and lenders offer diverse credit products to meet the needs of their customers.
Three primary types of credit products lenders offer consumers are revolving credit, instalment products and open credit. The line of credit (LOC) is a type of revolving credit, which means that the borrower can access credit repeatedly up to a specific limit.
The LOC offers many benefits for borrowers, especially MSMEs, the chief being flexibility; however, is it a good addition for the lenders for their product mix? The discussion below focuses on this aspect.
An Insight Into Line Of Credit
The LOC is a predetermined borrowing limit available to a customer when the credit line is active. It is a flexible revolving credit account that lets a customer access funds up to a predetermined credit limit.
LOC can be compared to a credit card, where the borrower withdraws funds when needed instead of purchasing an item. The customer pays interest only on the amount used, not the entire credit line.
The lender determines the overall credit extension based on the borrower’s creditworthiness. The advantages of a LOC for the borrower are:
- Flexibility: The most significant advantage a LOC offers is flexibility. The borrower can access cash at frequent intervals, repay and borrow repeatedly. Thus, funds are available as and when the user needs them, and the repayment schedule is also adjustable.
- Lower interest: The borrower pays interest only for the amount they utilise, not the entire sanctioned credit line.
- Tackles costs: Lines of credit help cover unexpected expenses, manage cashflows, finance short-term projects, and serve as a safety net for unforeseen financial emergencies.
- Control fluctuations: They help manage fluctuations in income and help borrowers avoid high-interest options like payday loans during lean periods.
Benefits of Adding Line of Credit to the Product Mix
Lenders consider the risk and profitability associated with each product before deciding what to include in their product portfolio. Each loan type carries a different type of risk; lenders should ascertain whether it fits their overall business strategy and risk tolerance.
Adding a LOC to lending products has the potential to provide the following benefits:
1. Loan Portfolio Diversification
Lending involves an inherent risk of default on payments by the borrower. Lenders can manage this risk by diversification at the borrower and portfolio level.
Different types of credit products react in different ways in diverse market conditions. Some products may get affected adversely by certain situations; their performance will be balanced by other loan products that may perform better during the same period.
Adding the LOC to the product mix will enhance portfolio diversification, reducing the probability of poor performance and will increase its resilience.
2. Helps Improve And Strengthen Customer Relations
The line of credit offers many benefits for borrowers. Customers may not want to opt for traditional loan products, where they have to pay interest on the entire loan from the day the loan is sanctioned and may prefer the LOC option, where interest only builds up when money is accessed. If the lender does not offer the line of products, the customer may approach a different lender.
Customers, especially businesses, want to have a relationship with a bank that can meet all their different requirements. When they look for a banker, they prefer a lender that offers them term loans as well as lines of credit to help them meet their different credit needs.
Thus, adding lines of credit can help lenders attract new customers and build stronger relationships with existing customers.
Lenders can offer customised solutions using digital platforms like embedded loan lines from Finezza. This allows lenders to adapt credit conditions to their consumers and add value to the credit line operation, making it an efficient and profitable core strategic enabler.
3. Enhances Income Potential
Lenders can charge higher interest for lines of credit, compared with other products like term loans, which can help them enhance their income potential.
Lines of credit can cater to a broader range of customers owing to their flexibility, which can help lenders attract more customers and, in turn, improve their income prospects through the interest they charge on the LOC.
Line of Credit: Some Concerns
There are a few aspects to consider before adding a LOC to the product line:
1. More Risk of Default
Unsecured lines of credit are inherently riskier than secured loans as the borrower does not offer collateral for them. Lenders can manage this risk by having a more stringent screening process at the time of sanctioning and better monitoring.
Choosing the right credit underwriting Software can help lenders make better credit decisions through reliable credit scores, document verification, and assessing alternate data points.
2. Higher Operational Costs
Managing lines of credit is more expensive for lenders due to the continuous monitoring and credit checks required. Lenders can manage these costs by improving their processes and efficiency.
Automation helps lenders at each stage of the lending lifecycle; it can help them reduce their onboarding and loan management costs. Automated systems help reduce the time required to process credit without compromising accuracy, which can help lenders process more applications in less time and improve overall productivity.
To Sum It Up
The LOC offers many benefits to borrowers and lenders alike. A few additional factors can help them make this decision: lenders should consider:
- Who their target market is, and if adding the LOC will help them attract customers and retain existing ones.
- What is the lender’s risk tolerance, and if the LOC is a good fit for their tolerance level?
- If competitors offer a LOC to their customers, then the lender should also consider adding it to their product line to stay competitive.
In the current environment where customer needs, market conditions, and regulatory frameworks evolve fast, managing multiple loan types can become simple for lenders by using the right lending software.
Finezza offers a loan management system that supports different types of loans like tenure loans, OD loans, revolving credit, equipment loans, and more.
Contact us to know more.
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