What is a business line of credit?
A business line of credit (LOC) is a flexible loan for businesses that works like a credit card. Companies draw money from their credit lines as needed, only paying interest on the portion of money borrowed. For revolving lines of credit, as the borrower repays the amount borrowed, they replenish the funds available. These funds can typically be accessed using a business checking account or mobile app.
How does a business line of credit work?
Business lines of credit are similar to business credit cards. Both allow small businesses to access funds when needs arise instead of the lump sum a business loan would provide. Interest rates on business lines of credit are typically lower than those of a business credit card.
Lenders set credit limits and interest rates based on factors like how long the current owner has been in place and what the company’s annual revenue is. An LOC typically requires renewal annually.
The repayment process varies from lender to lender. With some LOCs, you can make interest-only payments during your draw period. A repayment period of up to five years follows the draw periods. Other lenders treat each draw like an individual term loan — you have a set period to repay each draw you make, which could be weeks or months long.
Secured vs. unsecured business line of credit
Business lines of credit can be unsecured or secured by business assets as collateral. Whether or not you should secure your line of credit depends on the features you’re looking for. A secured credit line helps lenders offer you more flexibility — high loan amounts or lower interest rates. It may also help startups or business owners with bad credit get approved for a credit-builder line.
But if you don’t have much in the way of assets, you could qualify for an unsecured line of credit based on your business’s credit history and financial statements. You will need a stronger financial picture to qualify for an unsecured line vs. a secured line of credit.
Business line of credit vs. business credit card
Business lines of credit and business credit cards both let companies draw funds from a pool of credit on an as-needed basis. While both have their advantages and disadvantages, the best business credit cards have features you won’t find with business lines of credit.
Loan amounts
Lines of credit typically have loan limits of up to $100,000 to $250,000, though some lenders like Wells Fargo, Fundible and Backd offer even higher limits.
Credit cards don’t typically publish credit limits, but it’s likely most business credit cards have lower limits of $100,000 or less. One notable exception is the Divvy Business Card, which offers limits up to $15 million along with rewards for purchases and other benefits of business credit cards you won’t find with business lines of credit.
Interest rates
Business lines of credit may have lower interest rates, especially those offered at banks and credit unions. This can be especially appealing to business owners with excellent credit who are likely the rare few to qualify for the best rates on lines of credit or business credit cards.
But many line of credit lenders won’t disclose the maximum rates for their business lines of credit, which can soar far beyond the maximum limits of business credit cards. For example, the average interest rates for OnDeck lines of credit is 52.60 percent APR.
Some business lines of credit use factor rates instead of interest rates. These are usually reserved for lines of credit available to business owners with bad credit. When you convert factor rates to interest rates, the rates are typically higher than what you'll find with a business credit card. But to be sure, you'll need to know how to convert factor rates to interest rates, which will make it easier to compare loans.
The maximum interest rates for business credit cards tend to be low, even for business owners with poor credit. For example, the Spark 1% Classic from Capital One is open to business owners with a personal credit score of 580 or higher. Its variable rate isn’t as impressive as Wells Fargo’s business lines of credit, but it is far lower than the maximum rates found with business LOCs offered by many online lenders.
Grace period
Business lines of credit charge interest the moment you withdraw funds. That interest continues to grow until your balance is paid in full. Business credit cards work in the same way with one exception — many credit card issuers offer grace periods on purchases.
Between the end of your billing cycle and your payment due date, you have a chance to pay your balance in full and avoid interest charges. Grace periods are at least 21 days and only apply to purchases. If you were to use your business card for a cash advance, the interest would begin accruing immediately and would continue to grow until you paid your balance in full.
Business line of credit vs. business loan
A business line of credit is a revolving type of business loan. A business can withdraw funds whenever the need arises, as long as the credit limit isn’t exceeded. Interest then accumulates on the funds that are drawn, usually at a variable rate. Repayments are made daily, weekly or monthly. For these reasons, a business line of credit can be useful for small business owners looking to cover short-term needs.
In contrast, a small business term loan is a lump sum of money given with a fixed interest rate and paid back through fixed monthly payments. Loan payments start immediately, whether a business uses the money right away or not.
Borrowing limits are often lower on a line of credit than on a business loan, typically ranging from $2,000 to $250,000. But some lenders offer secured lines of credit, which offer higher limits. Secured lines of credit require that you provide collateral.
Additionally, business loans are typically limited to predetermined uses, like purchasing new equipment, while lines of credit are more flexible, allowing you to use the money for whatever business expense you choose.
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