A business line of credit is a type of open-end loan that allows you to withdraw money as needed for your company. These types of loans are crucial when opportunities or emergencies arise and cash flow is needed immediately. By having a line of credit for your business, you don’t waste valuable time going through an application and approval process each time you need to borrow more money. Business owners typically use these lines of credit to buy inventory and equipment, address periodic changes in revenue, manage cash flow shortages and increase working capital.
- How Do Business Lines of Credit Work?
- Business Line of Credit Providers
How Do Business Lines of Credit Work?
To understand how a business line of credit works, it’s important to understand the different types of loans. An open-end loan allows a borrower to withdraw, repay and redraw repeatedly up to a certain amount until the end of the term. Open-end loans are often referred to as lines of credit, revolving lines of credit and revolving loans. Examples of open-end loans can include overdraft accounts, credit cards and various lines of credit. A closed-end loan is a type of loan where money is disbursed once upfront and repayment must be made in full by the end of the term. Mortgage loans, car loans and business term loans are all examples of closed-end loans.
Let’s say Michael is a business owner who applied and has been approved for a business line of credit in the amount of $50,000. Michael eventually runs into some cash flow problems and needs money to pay his employees. Michael conveniently draws $20,000 on his business line of credit the next day. From the moment Michael draws the $20,000, he begins owing interest and must pay back the $20,000 in six months according to his agreed-upon loan repayment plan.
Two months later, Michael has already paid back his $20,000 draw early and wants to take advantage of a business opportunity he has come across. Michael is free to draw the maximum $50,000 amount from his business line of credit to finance this business opportunity. Much like a credit card, Michael can repeatedly draw on his business line of credit up to his maximum credit limit of $50,000.
Pros and Cons of a Business Line of Credit
The advantages of business lines of credit over a business term loan is that money is readily available when needed, money can be withdrawn repeatedly up to the maximum credit limit and interest is only owed on funds once they are drawn. While business credit cards are another type of open-end loans that are useful for quick access to capital, business credit cards should be used for smaller purchases that can be paid off within the month as to not incur any finance charges. Compared to business lines of credit, credit limits on business credit cards are also generally lower and interest rates are generally higher (especially on cash advances). The biggest disadvantage is that most loans have a variable interest rate. That means the total amount that needs to be paid back will change over time as the economy fluctuates.
Business Line of Credit Terms and Features
Business lines of credit can be secured or unsecured. A secured loan (i.e., one secured by collateral) will often provide better rates and easier approval for lower credit scores. An unsecured loan, however, will provide you the peace of mind that other assets are not at risk in case of delinquency or non-payment.
Business lines of credit can be obtained from both traditional banks and alternative lenders. Similar to business term loans, business lines of credits from traditional lenders such as banks and credit unions will have the best rates and terms, but are harder to qualify for. While alternative lenders are easier to qualify for, they provide higher rates and tougher terms. Terms and features of business lines of credit vary largely between lenders. The chart below will give you an idea of the most common terms and features for business lines of credit.
|Years in Business||1 year+|
|Loan Amount||Up to $100,000|
|Loan Term||Up to 5 years|
|Repayment Period||6 months after each draw|
|Rates||Variable (Prime Rate + Additional Rate)|
|Recurring Fees||$150-250 annually|
How to Qualify for a Business Line of Credit
Qualifying for a business line of credit is similar to qualifying for any other business loan. Good credit history is important so make sure you aren’t maxing out your credit cards every month. Additionally, make sure you’ve checked your financial statements for accuracy. Lenders will be looking at your annual revenue, whether you have positive cash flow and how long you’ve been in business. The application process for business lines of credit is similar to the application process for business term loans. To prepare yourself for the application process, check out our guide for getting a small business loan.
Business Line of Credit Providers
A good move for your business is to apply and get approved for a business line of credit in advance before you really need it. Business lines of credit are available from both traditional banks and alternative lenders. The SBA also offer lines of credit up to $5 million through intermediary lenders as part of its CAPLines program.
Each type of lender has its advantages and disadvantages that will vary widely depending on your individual circumstances. Make sure to check with your local bank and/or credit union and shop around for the best rate for your business’s particular profile. Below we've listed some line of credit options offered by major national banks and online lenders.
|Bank of America||$10,000||$100,000|