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.
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.
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:
- Quarterly tax payments
- Past-due invoices
- Seasonal lulls in your business
- Operating expenses
- New hires
How does a business line of credit work?
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
Business lines of credit vs. business credit cards
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.
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
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.
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.
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.