Types of business lines of credit
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If you need access to short-term funds or want to build credit, a business line of credit may be the answer. While a business loan gives you a lump sum of money that you pay back over time with interest, a business line of credit is more like a business credit card. It’s a revolving line of credit you can repeatedly access and only have to pay interest on the funds you borrow.
Business lines of credit typically have higher interest rates than business loans, come with lower borrowing limits and have shorter repayment periods. But they can be easier to qualify for and can be a better fit for small business owners looking for ways to better manage their cash flow.
Want to learn more? Here’s a look at two of the most common types of business lines of credit.
Secured business lines of credit
Secured business lines of credit require collateral. This is an asset you own that you’re willing to forfeit to the lender if you fail to pay back your debt.
When you secure a loan or line of credit, the lender places a lien on the collateral. This is a legal notice that gives the lender the right to take your asset if you stop making payments. The lender can then sell it to recover any debt you owe.
Putting up some collateral for your business line of credit can make it easier to get approved for the loan. This makes them accessible to business owners with poor credit. Securing the line of credit with collateral can also lead to more favorable terms, like a lower interest rate, increased loan limit or better repayment terms.
That said, securing a loan also means exposing the asset you use as collateral to the risk of seizure if you default on the line of credit. So business owners should think carefully about what they use to secure their business line of credit. Some of your options include:
- Commercial or personal real estate
- Company equipment or vehicles
- Investments (such as bonds or stocks)
- Outstanding invoices
Unsecured business lines of credit
Unsecured business lines of credit don’t need collateral to back the loan. That makes it riskier for the lender, which is why this type of business loan usually comes with a higher interest rate and lower lending limits than secured lines of credit.
Even though you don’t have to put up collateral, the lender may require you to sign a personal guarantee. This means you are still responsible for paying back the debt, and the lender can sue you for any unpaid balance. Even if you establish your business as a limited liability company, you are still liable for the debt once you sign a personal guarantee.
On top of all of this, an unsecured business line of credit can be harder to qualify for than a secured one. Because it heightens the risk for the lender, you generally need to show good credit and that your business has been operating for a while with a steady annual revenue.
Where to get a business line of credit
The best business lines of credit for you could come from a variety of places: a bank, credit union, fintech company or direct lender.
Long-established banks like Bank of America or Wells Fargo provide lines of credit. But the application process with traditional banks is often long, and it can take days or weeks to get funding.
Newer players in the game, including fintech companies like Credibly or Bluevine often offer faster applications and funding within hours or days. The downside of online lenders is that interest rates are usually much higher than traditional banks.
Ultimately, the key is to compare the amount of the line of credit, its repayment terms and the associated fees to find the right option for your business. At the same time, make sure you choose a reputable, trustworthy lender.
According to the Federal Reserve’s 2022 Small Business Credit Survey, respondents noted the following challenges:
- Online lenders: High interest rates (43%) and unfavorable repayment terms (34%)
- Large and small banks: Long waits for credit decisions and funding (42%) and difficult application process (41%)
Pros and cons of business lines of credit
Here’s a look at the top advantages and disadvantages of business lines of credit.
- Faster and easier than business loans. Getting a business line of credit is generally easier than getting a business loan. Plus, these loans usually get funded faster than traditional business loans.
- Improves cash flow. With the business line of credit, you get a way to access the money your business needs when you need it.
- Pay interest only on what you use. A business loan means getting a lump sum, then paying interest on that full amount. With a business line of credit, you can draw only what you need, minimizing the amount you need to pay in interest.
- Higher interest rates than business loans. Partially because they’re easier to get, interest rates for business lines of credit are usually higher than business loans.
- Fees. Lenders may charge certain fees, like an origination fee, draw fees when you pull from the line of credit and maintenance fees for months when you don’t.
- Harder to get than a credit card. The process for getting approved for a business line of credit is more rigorous and requires more documentation than getting a business credit card.
If your company needs short-term financing, a business line of credit offers you an option somewhere between a business loan and a business credit card. You’ll pay more in interest than you would with the business loan, but you’ll have an easier, faster time securing funding. Plus, you’ll get a revolving line of credit, meaning once you pay back what you borrowed, you can draw from the line of credit again.
Frequently asked questions
Each lender has its own application process. Generally, you’ll need to provide your federal employer identification number (EIN) and your own Social Security number so the lender can check your credit score. You should also be prepared to show the lender your business accounts and other important business documents.
A business line of credit may have a short, negative effect due to a hard credit pull. But as you pay it back on time, it can help you build your score, especially if you keep your credit utilization ratio low (keep your available credit high and your debt low). If improving your credit is important to you, double-check that the lender reports to a credit bureau. Not all lenders do, especially online lenders. You’ll need to find a bureau-reporting lender in order for the line of credit to impact your score.
Most lenders require a business to be operating for one to three years. Some online lenders only require six months. If you’ve been in operation less than six months, a business credit card may be a better fit.