A small business line of credit can help small business owners maintain consistent access to funds to smooth out the ebb and flow of changes in business expenses and revenues.
You may be thinking: “My business is profitable, we don’t need to borrow.” But many businesses with and without cash flow issues keep a line of credit handy for unexpected growth or expansion opportunities. A business credit line is a flexible, often low-cost way, to get short-term financing to cover working capital needs.
Business line of credit basics:
- How does a business line of credit work?
- Benefits of a business line of credit
- How to get a business line of credit
- When a business line of credit is a good idea
- Best business lines of credit
- Frequently asked questions (FAQs)
How does a business line of credit work?
A business line of credit is a flexible loan option for businesses. It may also be referred to as a revolving line of credit. You’re familiar with a line of credit if you use a credit card. It allows you to access funds from your credit line, pay back some or all of it, and access it again. With a line of credit, the business owner decides when, if, and how they will use that borrowed capital.
Interest is typically only charged for the amount of the credit line that is accessed, and interest rates may be fixed or variable. Variable interest rates typically change when interest rates in the economy change. Some lenders charge a draw fee every time you access the credit line.
In addition, there may be an origination fee, annual fee and/or a monthly maintenance fee if you don’t use your line of credit. For any line of credit you consider, you need to carefully read the terms offered to make sure you understand any fees that may be charged.
There will be a specified repayment period, but payments will vary depending on the amount borrowed. With some lines of credit (especially those from traditional banks), there may be a draw period during which you can access funds and make interest-only payments. After that, the business owner may enter a repayment period during which the outstanding balance must be repaid over a specific period of time.
Online lenders, on the other hand, often typically offer short-term lines of credit that fully amortize (or must be paid back) over a shorter time period, often 6 – 24 months.
Benefits of a business line of credit
Here are a few examples of scenarios where your business may benefit from a business line of credit:
- Your business has seasonal fluctuations—perhaps your sales take a dip in the summer or winter, for example.A line of credit will help during periods of low sales.
- Your clients take weeks (or longer) to pay you for products or services you provide. You might need a line of credit to cover business expenses while you wait to get paid.
- You land a new client and need extra capital to cover the cost of labor and/or supplies.. A line of credit can cover expenses during production.
- You have the opportunity to purchase equipment or inventory at a reduced cost. You can cover the bill with your line of credit while you wait for cash flow to catch up.
How to get a business line of credit
You can apply for a line of credit through a bank or credit union, an online lender, business loan broker or through an online marketplace where you’ll be able to shop among various lenders. Lenders will most likely evaluate:
- Time in business: 2 years or more is ideal but some are more flexible.
- Personal credit scores and/or business credit scores: Lender qualifications vary but many require personal credit scores of 600— 650, and banks often want even higher scores.
- Revenues: These will be verified via bank statements, financial statements and/or tax returns.
If you do not have a business bank account, you will find it more difficult to qualify. In addition, some lenders will not lend to sole proprietors, so incorporating your business as an LLC, S Corp or C Corp can be helpful.
When a business line of credit is a good idea
Similar to most business financing options, the best time to get a line of credit for your business is when your business has healthy revenue and cash flow, rather than when your business is in a cash flow crunch. You’re more likely to qualify for the best terms when your business is in good financial shape and has no cash flow problems.
Remember: you’re only charged interest on the amount you borrow. If you secure a line of credit now you’re not obliged to use it, but it will be there when your business needs some extra capital.Pro tip: While a business line of credit can be useful to most business owners, if you are looking for a lump sum of money to fund a one-time project or a long-term project, a small business loan (particularly a term loan) might be a better fit for you than a business line of credit.
Best Business Lines of Credit
Fundbox is a popular online lender. Your business must be based in the US and should have been in business for at least 6 months with annual revenues of at least $100,000, a personal FICO score of 600+ and a business checking account. If you qualify, you’ll make weekly payments for 12 or 24 weeks. Interest rates vary.
Ondeck offers fast approval online for lines of credit between $6000 and $100,000. Qualifying borrowers make weekly payments for 12 months. Interest rates vary. There is no prepayment penalty.
Some businesses qualify for SBA loans. These are small business loans that generally are made by financial institutions and guaranteed by the Small Business Administration. Most SBA loans are term loans but there are options that include lines of credit. Rates and terms on these loans are often very attractive but expect the application process to take at least a month, and sometimes longer.
FAQs about small business lines of credit
What is a secured vs. unsecured business line of credit?
With a secured line of credit the borrower puts up collateral as a security deposit on the line of credit. Putting up property as a form of collateral is common, but this could also be other assets owned by the business, such as equipment or inventory.
Secured credit lines may be preferred over unsecured lines by traditional financial institution like a bank or credit union. The lender is taking on less risk, so they may grant a higher credit limit at a lower interest rate for a secured credit line. New businesses or businesses with poor business credit might only qualify for a secured line of credit because of the inherently higher risk associated with a shorter track record or a weak credit profile.
In contrast to a secured line, an unsecured business line of credit does not require specific collateral. Unsecured lines of credit can be more expensive because the lender assumes higher risk. Credit cards are a type of unsecured line of credit. Businesses with many years under their belts and stellar business credit reports are more likely to qualify for unsecured business credit lines at reasonable rates.