Advertisements

What is a Business Line of Credit & How Does it Work?

What is a small business line of credit?

A small business line of credit has more in common with a small business credit card than a small business loan.

Like a small business loan, an unsecured line of credit gives a business access to funds that can be used to generate any business expenses. Unlike a small business loan, however, no one-time disbursement is made upon account opening that requires subsequent monthly payments.

Advertisements

A small business line of credit is subject to credit review and annual renewal, and is revolving like a credit card: once you withdraw funds, interest begins to accrue, and the amount you pay (interest) begins to accrue. (Except) is available for re-borrowing after you pay your balance. Like a credit card, the lender will set a limit on the amount you can borrow.

When should you use a business line of credit?

A business line of credit is ideal for companies looking for flexible financing options. You have ongoing working capital needs and you want cash flow to be available to cover business expenses as they arise. Read our best options for startup funding for more information.

Advertisements

For many businesses, cash flow varies from month to month, and there can be discrepancies between the amount coming in and the amount going out. And often there are expenses that are difficult to plan.

A business line of credit gives you access to the funding you need, with lower interest rates than you would typically pay for a credit card. It can help you cover a variety of expenses, such as:

Advertisements
  • Quarterly tax payments
  • Past-due invoices
  • Seasonal lulls in your business
  • Operating expenses
  • New hires
  • Equipment

How does a business line of credit work?

5 Tips For Managing Big & Small Business Finances - Finance Talk

A business line of credit works similarly to a credit card. With a line of credit, you gain access to a set amount of capital — say, $150,000 — and can draw on funds as needed. You only pay interest on the amount you withdraw.
You then pay the money back over time, usually on a weekly or monthly schedule. Many lenders allow you to pay off your entire balance early to save on interest costs. Some lenders charge additional fees, such as:

  • Origination Fee: Charged to process your application.
  • Account Maintenance Fee: Monthly or annual fee associated with managing your account and keeping your business’s line of credit active.
  • Draw Fee: A fee is charged each time you draw on your line of credit.
  • Inactivity Fee: A lender may charge this fee if you do not withdraw from your line of credit within a specified period.

You can continue to draw on your business credit line as many times as you want, as long as you make payments on time and don’t exceed your credit limit. Since small-business lines of credit are rotating, they are much more flexible than business term loans, which require you to repay a lump sum amount over a set period.

Secured vs. unsecured business lines of credit

A secured business line of credit requires you to put up assets such as inventory or property as collateral. If you fail to pay back the credit line, a lender could seize your assets.
Unsecured business lines of credit, on the other hand, don’t require collateral, but some lenders may still require a personal guarantee or a lien on a business’s assets.
A personal guarantee gives a lender the right to go after your personal assets, like your house, if you default on a loan. A lien is similar; a lender can seize your business assets if you haven’t repaid a loan.
When comparing lenders, ask whether they require collateral, a personal guarantee or a lien so that you can find the option that’s best for your business.

Business lines of credit vs. business credit cards

Business credit cards are technically lines of credit, but they differ from traditional business lines of credit in several ways.
A business line of credit can provide a higher credit limit, may be secured by collateral and provides actual cash in your bank account when you make a draw. You can get cash with a business credit card, but you’ll be charged fees (usually called a cash advance fee) and a higher APR to do so.
Business credit cards, however, can provide rewards or cash back for spending — which is not something offered by traditional lines of credit. Rewards are typically related to business expenses, such as office supplies, gas, internet and cable. They may also offer 0% interest promotions, which allow you to pay no interest on your balance for a specific time period after signing up for the card.
Business credit cards work best for smaller ongoing expenses and for newer businesses without established finances, while business lines of credit work best for larger ongoing expenses and more mature businesses.

Using a small business line of credit

The number-one reason to open a business line of credit is to gain access to short-term funding. Most businesses use these funds to support financing for operational expenses like supplies and payroll or for increasing inventory. Cyclical businesses often rely on an unsecured line of credit as a source of off-season working capital.

Advertisements

Unlike many small business loans, an unsecured line of credit is not designated for a specific purpose or purchase — it’s a good choice for small businesses looking for ways to better manage cash flow. Funds are typically drawn from the line of credit by using a business checking account, a small business credit card or even a Mobile Banking app.

Understanding secured and unsecured lines of credit

Top 10 Best Business Ideas For Couples In 2021

A small business line of credit is typically offered as unsecured debt, which means you don’t need to put up collateral (assets that the lender can sell if you default on the debt). Many unsecured lines of credit come with a variable interest rate and are available for sums ranging from $10,000 to $100,000.

For amounts greater than $100,000, you may be required to secure your line of credit with a blanket lien on your assets or a certificate of deposit.

Advertisements

What’s required to obtain a small business line of credit?

Be sure to research the specifics of any lender’s business line of credit requirements. For example, many banks will require a business to have been under current ownership for some fixed amount of time.

Advertisements

Rates for a business line of credit tend to be lower than those for a business credit card, which can charge more than 20% APR for purchases — and even more than that for cash advances.

Leave a Comment