What Is a Standby Line of Credit?
A standby line of credit is a sum of money, not to exceed a predetermined amount, that can be borrowed either 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 sure.
- A standby line of credit is a sum of money, not to exceed a predetermined amount, that can be borrowed either in part or in full from a credit-granting institution if the borrower needs it.
- Fees are typically charged by financial institutions to establish a line of credit of this type.
- A reverse mortgage may include options that allow the borrower to access funds through a standby line of credit feature of their account.
- Companies, not just financial institutions, may also offer standby lines of credit to other businesses.
How a Standby Line of Credit Works
One situation where a business might establish a standby line of credit with a financial institution is if the business needs to guarantee that it is able to pay a certain amount of money to a client if the business fails to perform on a contract adequately.
In this situation, the standby line of credit would act as a kind of performance bond. The standby line of credit could 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.
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. In this case, the standby line-of-credit 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 based on prevailing market interest rates. These market interest rates are typically tied to a short-term benchmark interest rate such as the federal funds rate or the prime rate plus some spread or margin.
It is important to note that interest rates on a reverse mortgage line of credit are variable. Fixed rates are only available with lump-sum distributions. If you are considering a reverse mortgage, it may be in your best interest to seek the advice of a qualified financial advisor to fully understand how it works, and what alternatives may be available. There are additional options for accessing your home's equity, such as a home equity line of credit (HELOC).
Companies, not just financial institutions, may also offer standby lines of credit to other businesses. Such financing might be made available by a company, or companies, that own shares of the business that is seeking the line of credit. Stakeholders may do this as a way to further support the growth and development of the business that they have shares in.
Standby Lines in Use
For example, one or more entities might make their 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 containing collateral could offer a standby line of credit equal to the assets it contains. This would be considered a secured 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.