Owning a business comes with unique challenges, especially if you lack large cash reserves for emergencies. Whether you need to cover payroll, standard expenses, or unexpected emergencies, opening a business line of credit can help you manage short-term cash flow needs. What is a business line of credit, and how does it differ from business loans? Do you need a business line of credit, or would a business credit card have you covered?

The answers to these questions typically depend on your type of business, specific financial needs, and creditworthiness. Read on to discover how business lines of credit can help your business not only survive, but thrive.

What is a business line of credit?

A business line of credit is similar to a business credit card. Instead of a traditional loan, where a lump sum is disbursed and paid back over time, a line of credit acts as “funds available.” For instance, if you had a $15,000 line of business credit, you could draw up to $15,000 to use for expenses.

Funds are usually available through a business checking account, credit card, or mobile app, depending on your lender.

As you draw upon the business line of credit, the available amount goes down. Paying off the line of credit restores the available funds. Like business credit cards, interest rates apply to the amount borrowed.

Business lines of credit are contingent on credit review. The credit limit and interest rate will vary depending on your business and personal credit. Each credit line must be renewed annually. If you are unable to secure a business credit card, you may be similarly limited with a line of credit.

How does a business line of credit work?

A business line of credit is ideal for short-term funding needs. When disaster strikes—such as an unexpectedly slow month, non-paying clients, or even a global pandemic—you may not have enough cash on hand to pay your bills. With a business line of credit, your company can still cover payroll, rent, utilities, and other urgent expenses. When cash flow returns to normal, the borrowed amount is repaid with interest.

Interest rates may be variable or fixed. Fixed interest rates stay the same over the course of the loan. Variable rates can fluctuate, depending on overall interest rates. They can range from 10 to 99%. Make sure to understand what kind of interest rate you’re signing up for, because it could dramatically impact your business’s financial health.

Typically, creditors allow business owners to repay early to avoid interest. This is similar to credit cards. Paying within the grace period ensures no interest is accrued. Depending on the lender, you may be subject to weekly or monthly payment schedules.

Some lines of credit also charge fees. These include:

  • Application or origination fee: This fee is charged when you apply for the line of credit, regardless of whether credit is granted.
  • Withdrawal fee: Some lenders charge a fee every time you withdraw against your credit. This is often 1 to 2% of the amount withdrawn.
  • Late fees: Miss a payment? Your lender may charge additional late fees on top of the interest you’re already paying. Review your payment schedule so you know your obligations.
  • Inactivity fees: Your creditor may charge a fee if you don’t draw on your credit within a certain period. If your company rarely has a need for short-term funding, look for lenders who do not charge inactivity fees. However, depending on the fee amount, it may be worth paying just to have access to short-term funding.
  • Account maintenance fee: Account maintenance fees may be charged in addition to inactivity fees. These are usually monthly or annual fees. Failing to pay could inactivate your line of credit.

Owners can continue to draw upon business lines of credit as often as they like, as long as there is credit available. However, withdrawal fees and interest rates will add to the ultimate amount owed. Be sure to consider all applicable fees when applying for and using your line of business credit.

Unsecured vs. secured lines of credit

Business lines of credit may be unsecured or secured. Secured lines of credit require collateral. This is usually inventory or business property. Should your company fail to pay back the credit, the lender can seize the assets to make up for their loss.

Unsecured lines of credit do not require collateral. These lines of credit typically range from $10,000 to $100,000. However, they may require personal guarantees or a lien on business assets. A personal guarantee renders you personally liable for the amount borrowed—even if your business fails. A lien on business assets enables the lender to seize those assets to repay the loan.

It’s important to review each lender’s terms before choosing a creditor. Failing to repay your line of credit could result in serious consequences. Your personal and business credit could be affected, your business assets may be subject to seizure, and you could end up personally liable for paying significant amounts of cash, even if your company is a corporation or LLC.

What can you do with a business line of credit?

Business lines of credit can be used to fund short-term expenses, including:

  • Cash flow emergencies
  • Seasonal slowdowns
  • Building inventory
  • Finance accounts receivable
  • Covering payroll

Like business credit cards, business lines of credit should be used exclusively on business-related expenses.

How do you get a business line of credit?

The process of applying for a business line of credit is very similar to applying for a credit card or loan. It  involves five basic steps:

  1. Identify funding needs: First, decide how much funding you need. Applying for a higher amount of credit can be prudent, since you only pay fees and interest on the amount actually borrowed. Lines of credit generally range from $2,000 to $250,000. As with credit cards, it can be tempting to over-borrow. Remember, you or your business could be liable for any funds you fail to repay. Most lenders will let you request an increase in credit if needed later.
  2. Determine eligibility: Your eligibility depends on a few factors. Most lenders require a personal credit score of at least 680, but some extend credit to scores as low as 580. The minimum business credit score is usually 75. They will also review your revenue. Lenders typically specify minimum monthly or annual revenue. Finally, they’ll consider how long you’ve been in business. 1–2 years is standard. Some lenders will extend credit to businesses as little as 6 months old, but the interest rate and fees will be higher.
  3. Research lenders: Banks, credit unions, and online lenders all extend business lines of credit. Online lenders are typically better for new businesses or those with riskier credit histories. When researching and comparing potential lenders, remember to compare the type of interest, interest rate, fees, and whether the loan is secured or unsecured.
  4. Gather documentation: Typically, lenders require the following documentation: business license, articles of incorporation (where applicable), personal and business tax returns, personal and business bank statements, your business plan, building lease, profit and loss statements, and financial statements. Contact your lender to find out whether you’ll need additional documentation.
  5. Apply: The final step is to submit your application. This may be done online or in person, depending on the lender. You may receive an instant decision or need to wait several days. Once the application is accepted, your lender will send you contracts to sign.

Remember, your credit application depends on precision. Errors in your contact information, business documentation, loan amount, and other important information could delay your application. Your application can also be summarily denied. Double-check all of the information on the application, and be sure to present accurate, updated documentation.

If you’re denied by one lender, you may be able to secure a line of credit from another. This is when your research comes in handy: you should have at least two to three top contenders, plus reasonable back-up options.

Should you apply for a business line of credit?

Knowing what a business line of credit is enables you to make smart financial decisions. Should you apply for one?

The answer depends on your business’s creditworthiness, time in business, industry, and need for funding. Seasonal businesses often require credit as a stopgap solution, whereas a small Shopify or Etsy shop may not. Similarly, if you are not eligible for a business line of credit, you may need to pursue other funding options.

All credit should be approached with caution. Fees and interest can quickly snowball. It’s tempting to see it as a lifeline—and it’s also tempting to borrow beyond your company’s means to repay. Remember, you can always ask for an increase in credit later.

The bottom line

Business lines of credit go a long way toward bridging cash flow gaps. If you’re eligible, a line of credit offers peace of mind and security. Approaching credit prudently and cautiously will ensure that your company thrives for years to come.

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