Credit facilities are a popular form of borrowing, particularly in the commercial and corporate finance sectors. They offer individuals and companies a flexible and accessible way to borrow money for financing purposes. Let us go over all you need to know about credit facilities, including what they are, what types are available, and how they work.
Types of credit facilities
Credit facilities occur in a variety of types, including fund-based credit and non-fund-based credit.
1. Fund-based credit:
This type of credit facility involves a direct transfer of funds from the lender to the borrower. Fund-based credit is classified into several forms, including loans, cash credit, and overdrafts.
- Loans: A type of credit that must be repaid over a specific period.
- Cash credit: A credit facility in which the borrower can draw from the agreed-upon limit at any moment to meet working capital requirements.
- Overdrafts: This credit instrument allows a current account holder to withdraw funds in excess of their credit amount up to a certain limit.
2. Non-fund-based credit:
This type of credit facility does not entail the direct transfer of the funds from the lender to the borrower. Examples of non-fund-based credit include letters of credit and bank guarantees.
- Letters of credit: A contractual agreement in which the lender guarantees payment for goods or services provided by the borrower.
- Bank guarantees: A guarantee granted by a bank that pledges to pay out the borrower's debt in the event of default.
Credit facilities have varying terms, interest rates, and fees. It is critical to understand which sort of credit facility will best meet your needs.
How credit facilities work?
When you apply for a credit facility, you provide information about your creditworthiness. Lenders use this information to calculate the amount of credit, interest rates, and fees. Once your application is accepted, you can use the credit facility whenever you require funds.
The repayment time is adjustable and depends on your credit history and previous debt repayment performance. Interest rates can vary as per the type of credit instrument (example: loan, credit card) offered.
Impact on credit health
Credit facilities provide access to funds to individuals and businesses. However, keep in mind that timely debt repayment is critical. If you miss repayment timelines, your CIBIL report may show a 'written off' status. This status indicates that you have been unable to pay your existing loans for more than three months. The ‘written off’ status can have a negative influence on your credit score and future borrowing ability.
To avoid any negative impact on your credit history, ensure that you fully understand the terms of any loan or credit facility you choose and make timely repayments.
To conclude, before borrowing, make sure to assess the benefits and risks associated with each type of credit instrument. Understanding the various types of credit facilities and how they work will help you make an informed borrowing decision. Whether you want to expand your business or fund personal expenses, credit facilities are a great alternative to consider.
