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Cash is something all companies seem to need more of at some point in their business life cycle. While there are several ways to get it, one path that seems to be growing in popularity is the business line of credit. Like loans, these come in two flavors: secured and unsecured. Here’s a bit more about the unsecured version and the possibilities it offers. It might be just what you need to grow your offerings or pay down more expensive debt.
What Is an Unsecured Line of Credit?
Before you can examine if this financial product is right for you, it helps to know what it is. Unlike a loan, which is paid back over time and then closed out, a line of credit can be borrowed against over and over. It works much like a business credit card in this way; some lines of credit won’t let you borrow any more until you’ve paid 100% back from your original borrowed amount, while others let you continue to borrow in any increment you wish. Your minimum monthly payment due will be determined by the amount you borrow and your interest rate (similar to a business credit card or loan.)
The unsecured part is where most business owners find the appeal. Because you don’t have to put collateral down to secure it, you can usually qualify as a newer business with fewer assets. You also won’t be putting your personal property, such as your home or car, at risk. Unsecured loans are like credit cards in this way.
Pros of an Unsecured Line of Credit
As we mentioned before, you won’t need to secure this loan with your business, home, or personal property. This is the number one perk for most people. The payment terms are incredibly flexible. You can pay more than the minimum payment to pay your debt down early; there is usually no penalty for this.
The application process can be more straightforward, too. With no collateral to ask about, you’ll be free from providing information on the deed to your home, for example, or need to demonstrate your personal net worth. For this reason, decisions can sometimes be made sooner. Many lenders will let you apply online and give you a preliminary decision right away.
One other perk of a business line of unsecured credit it what it can do for your business credit profile. With regular, on-time payments to your account, you will be boosting your business score. For those who want to someday qualify for a larger, formal business loan, this can often be the best first step to prove that you’re responsible and will be a good credit risk.
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Cons of an Unsecured Line of Credit
These offerings are usually smaller than secured loans or lines of credit. While those secured by collateral can total in the hundreds of thousands, you’ll probably find most unsecured loans to be less than $100,000 (and closer to $10,000 if your business is small or unproven.) These lines of credit usually have higher interest rates or fees since the bank needs to ensure profitability. With no collateral to ensure they can collect down the road, the lender will take their profit upfront in the form of interest paid.
Your credit score needs to be in shape to get this type of credit. If you’re not already familiar with both your business and personal scores, get those for free right away – and before you apply. Your business records, including sales and years in business, are even more critical for this type of credit. Newer businesses may find it hard to qualify.
It’s important to mention that unsecured doesn’t mean you won’t have to guarantee it with your personal information or credit score. Many applications will ask for things like your Social Security number and will run your personal credit to see that you are the kind of person who will pay the credit line back. You won’t need to put up your home for security, but late payments would affect your personal credit profile.
Tips for Applying
While each application will be slightly different, come prepared with the following piece of information:
- Business industry, sales numbers, and your EIN
- Tax returns (at least two years)
- Financial statements, profit/loss sheets, unpaid invoices
- Bank account information (should be business, not personal)
- Personal information, such as SSN, address, references
- Statement guaranteeing that you’re of legal age and authorized to sign contracts on behalf of the business
The application is usually just the start of the information a lender may collect. Don’t be surprised if they call or email you to obtain additional information or want clarification about something they didn’t understand.
When is an Unsecured Line of Credit a Good Idea?
There are many, many lenders out there competing for your business, so don’t jump into the first one you see. Comparison shop to get the right line for your needs, and avoid the temptation to borrow more than you have to, at first. Just because a line of credit is available, doesn’t mean you should take it all. If the bank were ever to ask you to pay it all back, you’d need to be able to do so.
It’s up to you to weigh the costs of this type of financial product with the benefits. For someone who needs cash quickly and can pay it back promptly, it can be a great way to jump-start a new line of business, fix broken equipment, or take care of very high-interest debt. Because the costs for an unsecured credit line can be higher than a secured loan, however, be sure you balance the pros and cons.
If you’re in a pinch, you may find it to be the best alternative (or, the only alternative) to keep your business running. It is also a good way to get into the business lending arena for bigger, more affordable loan options later on in your business life cycle. If nothing else, you can always apply for one to have on hand if something does go wrong. Many banks let you apply for a line and pay it back right away, or not use much of it, at all, to start.