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What is a Business Line of Credit?
A business line of credit is a flexible business loan that allows you to borrow up to a certain amount, or credit limit, to cover short-term working capital requirements. When you get a business line of credit, 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. Credit cards typically have higher interest rates and in many cases, a line of credit does not have a mandatory monthly payment system.
How a Business Line of Credit Works
Unlike a term loan, a business line of credit allows you to only pay interest on the amount you actually use. For example, if a business owner has a credit limit of $150,000 but only uses $40,000, they only have to pay interest on the $40,000 draw. Once the amount has been repaid ($40,000), the business owner can draw additional funds up to the amount of their credit limit ($150,000).
Types of Business Lines of Credit
There are several different 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 business 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.
Credibly provides access to both secured and unsecured business lines of credit with a maximum credit limit of $250,000.
Line of Credit vs. Term Loan
The main difference between a term loan and a line of credit is how you receive the money and the repayment terms. Term loans provide a specific sum of money that is repaid over a fixed period of time, otherwise known as the loan term. Lines of credit, on the other hand, provide a revolving account that allows borrowers to draw up to a certain loan amount, repay the amount borrowed, and redraw up to the amount of the credit limit to receive additional funds. Unlike keeping up with the fixed payments of a term loan, you will be required to pay interest on borrowed balance while the credit line remains open. In many cases line of credit, borrowers are required to meet a minimum monthly payment to avoid additional fees or penalties. Some lines of credit are open-ended; the line does not close after a certain period of time as it does with a term loan. Others may close or become inactive after a certain amount of time or period of inactivity.
Is a Line of Credit Right for My Business?
As a business owner, there are often times when working capital is tight. Without ample liquidity to cover business expenses like payroll, inventory, rent, and utilities it can be difficult to maintain operations. As one of the most flexible financing options, lines of credit are great for ensuring that you have the necessary working capital to meet your business needs and have access to emergency funds if needed.
For many businesses, a line of credit is the go-to solution for stabilizing cash flows as borrowers can secure access to funds and then draw at a later time when additional working capital is needed. It’s also a great option for those who need to remain adaptable. After all, small business owners often have a limited window of time to seize the opportunity when it arises. A line of credit allows you to quickly access the funding you need to pursue the initiative.
Because you only pay for what you use, lines of credit are also great emergency funds. That said, a line of credit would not be the right option in certain scenarios, such as trying to open a startup. This is because the total cost of capital is typically lower with a term loan.
How To Get a Business Line of Credit
Interest Rates and Fees
Credibly aims to make both funding and payments intuitive, convenient, and easy to handle. Interest rates and funding amounts begin at 4.8%** and are based on a review of your business, personal FICO score, and other factors. An origination fee may be required.
Line of Credit: Advantages and Disadvantages
While the flexibility and revolving nature of a line of credit make it a great fit for certain circumstances, it may not be the perfect financing fit for every need.
FAQs About Business Line of Credit
Is a business line of credit considered income?
The cash received from your line of credit is not income. While it does give you a quick cash infusion, you are borrowing the money and paying interest on the amount borrowed.
What are the 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.
Borrowers may not use their business line of credit for personal use. A financial penalty may result in the event that your lender finds you using your business line of credit to cover personal expenses.
Can you use a business line of credit for personal use?
No. Borrowers may not use their business line of credit for personal use. A financial penalty may result in the event that your lender finds you using your business line of credit to cover personal expenses.
Does opening a line of credit hurt your credit score?
Opening a new business line of credit may lower your credit score in the short term if the lender makes a hard inquiry on your credit. While this may cause your credit score to drop a few points temporarily, repaying your line of credit in a timely manner can actually help you build your credit.
Other Financing Options
Subject to approval.
*Bank statements must be from the business banking account for the business receiving funds.
**The rate is a simple interest rate calculated from total repayments over 26 weeks.