What is a business line of credit and how it works
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A business line of credit provides small business owners with access to short-term funding. You can use this credit line to help cover business expenses like paying your employees or purchasing inventory.
Read on to learn more about business lines of credit and to see if it’s the best business loan option for you.
What is a business line of credit?
A business line of credit is a flexible business loan that works similarly to a business credit card. Borrowers are approved up to a certain amount and can draw on their line of credit as needed, paying interest only on the amount actively borrowed. Funds are typically accessible through a business checking account or mobile app.
Unlike a traditional or term business loan, which disburses funds in a lump sum at one time and is repaid with interest, a business line of credit is renewable. As the borrower makes repayments, the amount of credit available is refreshed, similar to payments toward a credit card limit. Business lines of credit are typically approved for several months or up to several years, depending on the lender.
Secured vs. unsecured line of credit
A business line of credit is either secured or unsecured. A secured line of credit generally includes collateral, such as cash, investments, or real estate. The benefit, if you can provide such collateral, is generally more favorable loan terms and a lower interest rate.
How does a business line of credit work?
Business lines of credit have loan amounts that are generally smaller than traditional business loans and are often funded more swiftly. Though traditional banks may take days or weeks to fund, many online lenders can provide access to funds as quickly as within a business day.
Repayment terms will also vary from lender to lender, from as short as several weeks to as long as several years. Interest rates tend to be higher than traditional business loans. The rate you are given will depend on a number of factors, including your credit history.
Common fees you might find include an annual fee, an origination fee when you first apply, a maintenance or monthly fee on the account, and draw fees each time you pull from the line of credit.
Requirements for a business line of credit
When you’re ready to get a business line of credit, lenders will review your application to determine eligibility. Here’s a look at some of the important factors they will consider.
- Credit score. Lenders will consider your personal and business credit score. While it’s possible to get a line of credit with a low credit score, lenders typically prefer fair-to-excellent credit. The lower your credit score, the more you will pay in interest and fees.
- Annual revenue. Lenders will require that you have a minimum annual revenue. Some lenders are flexible and will consider businesses with an annual revenue of $36,000, but many prefer a revenue of at least $100,000 or higher.
- Time in business. This also varies by lender, but a minimum of six months to two years in business is standard.
- Collateral. If you can provide an asset to back your line of credit, you may qualify for a secured line of credit, which can come with lower interest rates.
Pros and cons of a business line of credit
- Improves cash flow.
- Quicker access to funding than many traditional business loans.
- Interest rates are typically lower than a business credit card.
- Interest rates and fees can be higher than term loans.
- Generally have lower business loan amounts.
- Eligibility requirements and the application process can be difficult.
A business line of credit can be an excellent and flexible solution for inconsistent cash flow in your small business. Comparing lenders to find a competitive rate and terms can save money over time.
While credit limits may be lower than what you could get with a small business loan, funds are often available more quickly, and borrowers can return to the well repeatedly without needing to reapply for funding.
Frequently asked questions
Lenders may look at both your personal and business credit scores. And while it’s possible to find a lender that offers a business line of credit to a business owner with bad credit, most lenders will require you to have at least fair credit.
Business loans are disbursed in one lump sum and repaid by the borrower with interest over time. A business line of credit is approved up to a certain amount, and lenders can repeatedly borrow, using and repaying credit as needed. Business loans tend to have more favorable interest rates and longer repayment terms compared to a business line of credit.
Banks, credit unions and alternative lenders may offer business lines of credit.
While some lenders may approve you using your Employer Identification Number (EIN) number alone, many will also require your social security number to determine creditworthiness. Many lenders will want a guarantee that you will be personally responsible for any debt you incur in the event your account goes into default.