What Is a Business Line of Credit?
A business line of credit is a type of revolving business loan. The lender approves you to borrow up to a certain amount of money and you’re able to access some or all of that money as you need it. After you fully pay off a portion you’ve used, the full amount of your line of credit is available for you to use again.
Although business lines of credit do operate very similarly to a credit card, they are not the same thing. A business line of credit typically has a lower interest rate than a credit card and in many cases, a line of credit does not have a mandatory monthly payment system.
How Is a Business Line of Credit Different From a Business Loan?
When you take out a business loan, you are given the full amount of the loan as a lump sum and it’s gradually repaid over time. As you make payments on your loan, you will be paying interest on the full amount of the loan, regardless of whether or not you’ve actually used all the funds from your loan yet. The funds from a business loan can only be used one time. If you pay off a loan and later need money to cover another expense, you would have to take out a separate loan.
On the other hand, a business line of credit can be borrowed against multiple times. If you use part of your line of credit and pay off the amount you used, the full amount of your line of credit is available for you to use again when you need it. Unlike a loan, you only pay interest on your line of credit when you actually use it, so you won’t have to worry about paying interest on something you’re not using.
Pros and Cons of a Business Line of Credit
A business line of credit is one of the most flexible funding options around. You can use as much or as little of it as you need to, you only pay interest when you use it, and the fact that it can be borrowed against multiple times makes it a very helpful thing to have available when you need it.
- Business lines of credit have better terms than credit cards.
- Some lines of credit require collateral, particularly for lines of credit that have very high limits.
- You may need to pay an annual fee, opening fee, or transaction fees.
Lenders might not be willing to issue a line of credit for a very young business or if the business owner has a low personal credit score. If they do, it would most likely be for a short-term line of credit with higher interest rates and lower limits.
Uses for a Business Line of Credit
Unforeseen expenses can happen to any business and a business line of credit can give you the peace of mind of knowing you’ll have an extra source of funding ready anytime you need it. A business line of credit can be used for a wide variety of purposes, including buying equipment, emergency repairs, renovating a storefront, purchasing inventory, and paying employees.
Business lines of credit can be particularly helpful for businesses that need some level of flexibility. They can be great for businesses in industries that face seasonal fluctuations and may occasionally need extra money to stock up on inventory or hire extra employees ahead of a busy time of year. If you’re planning a series of projects that would require extra funding now and then, you might like the flexibility a line of credit can offer.
Types of Business Lines of Credit
Just like a regular business loan, a business line of credit can be either secured or unsecured. A secured line of credit requires the borrower to put up an asset to be used as collateral while an unsecured line of credit doesn’t. Since an unsecured line of credit involves a higher risk on the part of the lender, the borrower needs to have a higher business credit score to be approved for one.
Business lines of credit also come in different term lengths: short term and medium term. Unlike with loans, term lengths have nothing to do with how long you have to make payments on it or how long it’s available to you. Instead, the different terms indicate things like interest rates and spending limits. For example, a short-term line of credit has higher interest rates, lower limits, and lower revenue requirements, similar to short-term loans. Conversely, medium-term lines of credit have lower interest rates and higher borrowing limits, much like a medium-term loan does.
Applying for a Business Line of Credit
Much like any other type of business funding, a lender will want to see proof that your business has been doing well and is capable of turning a profit. You may be asked to provide things such as:
- Past bank statements and business tax returns
- Your resumé and resumés for any business partners or other essential employees
- Business plan and your business history
- Revenue projections
- Avoided business check
- A copy of your driver’s license
- P&L statements
Lenders who offer business lines of credit will also want to know that you would only be using it for purposes that would help your business grow and continue to turn a profit, not for things like paying off past losses.
4 Types of Business Lines of Credit