DEFINITION of Standby Line of Credit
A standby line of credit is a sum of money, not to exceed a predetermined amount, that can be borrowed in part or in full from a credit granting institution if the borrower needs it. In contrast, an outright loan would be a lump sum of money that the borrower intended to use for certain.
BREAKING DOWN Standby Line of Credit
A business might establish a standby line of credit with a financial institution in situations where the business needed to guarantee its ability to pay a certain amount of money to a client if the business fails to fully perform on a contract. In this situation, the standby line of credit would act as a performance bond. The standby line of credit might be used as a backup source of funding in case the primary source fails.
Fees are typically charged by financial institutions to establish a line of credit of this type.
How Standby Lines of Credit Are Used
Other forms of financing such as a reverse mortgage may include options that allow the borrower to access funds through a standby line of credit feature of their account. The standby line of credit in this instance is not tied to the value of the home, which means the size of the credit line does not decrease with market fluctuations. Instead, the standby line of credit would increase with interest rates.
Companies, not just financial institutions, could offer standby lines of credit to other businesses. Such financing might be made available by companies or companies that own shares of the business that is seeking the line of credit. This may be done by stakeholders as way to further support the growth and development of the business they have shares in.
For example, one or more entities might make their own cash available to establish and offer a standby line of credit to another business. By splitting up the burden, they can offer the business an even larger line of credit. In such instances, the lenders might restrict the types of uses the standby line of credit is used for. This type of standby line of credit might be arranged through a bank or investment broker, where an account with collateral allotted to it equal to the amount of the standby line of credit. The collateral may include cash, money market funds, or publicly traded shares.
Terms of the standby line of credit will include a schedule for repayment of funds drawn down by the borrower.