Guide To Understand Business Line Of Credit for Your Small Business

Business Line Of Credit
Pinterest Hidden Image

Business owners know they need all the support they can get, especially regarding their financial needs. Just like everyone else, business entrepreneurs need to pay their bills, pay for equipment or inventory, pay employees’ salaries, and more. A loan is a practical solution when your business requires money for sudden needs. But what if you only require a fraction of the loan at given times? The answer? A business line of credit.

Unlike other types of loans, which can be more difficult to apply for and attain, business lines of credit can be easier and faster. But before you apply for such a loan, knowing as much as possible about it and how it can benefit you still pays. When a business borrows money, especially without collateral, approval requirements can be stricter, making a business line of credit a more attractive option.

Here is everything you need to know about a business line of credit and how it can help your business.

đź“– Key takeaways

  • For business owners who need that extra bit of cash, a business line of credit has become a more popular loan for growth and expansion, unplanned expenditures or emergencies, and so on.
  • A line of credit is a revolving loan that provides access to cash up to an approved credit limit. It helps cover ongoing cash-flow needs without pledging valuable assets and allows business owners to borrow and repay funds as needed.
  • A business loan provides a lump sum of funding, whereas a line of credit provides access to a credit limit. Business loans typically have fixed repayment terms, whereas business lines of credit have flexible repayment terms.

Business Line Of Credit: A Brief Overview 

A business line of credit permits borrowers to gain access to capital established at a fixed amount. Also referred to as a “revolving loan,” it is meant to fund short-term goals within business needs.

This tool for small-to-medium-business financing gives you room to borrow the loan without taking out the entire amount straightaway. If all you need is a fraction of it, for the time being, you can do so. And the remainder will continue to be preserved as a part of your loan and loan contract.

The most basic thing you need to understand about a business line of credit is that it is similar to a credit card for your business.

Unlike standard or traditional short-term business loans or term loans, a business line of credit does not give you a lump amount of cash you would have to pay back monthly on a set schedule. A line of credit will instead provide you with access to cash or capital of a specific amount, which you can withdraw whenever you need it or whenever it’s necessary.

With a line of credit like this, the balance will be revolving, meaning you can carry over the balance every month. The interest on the credit line will be calculated depending on the cash you withdraw, and you will only need to pay interest on the amount you use. Once you repay that amount, referred to as the principal, the credit available on your line will return to the set limit. You can then use the line again as necessary.

The main difference between a standard business loan and a business credit line is that the terms are more flexible with a line of credit. You can decide how much to borrow and when and only need to pay your interest on the amount you borrow. The fees for credit lines will also vary based on the lender and the credit line you opt for. The only restriction is that there is a set limit to your credit line, and you can’t go above that limit.

Why A Business Line Of Credit? What Will Your Business Get Out Of It?

1. Amazing Flexibility For Utilization 

As mentioned above, the main factor which differentiates a business line of credit from other types of conventional loans is its flexibility. “Flexibility” when pulling out the exact amount you need to address business demands immediately.  

This entails that you can utilize small portions of the loan at a time and repay only that portion according to the drafted repayment plan. 

2. Fewer Hassles For Repayment 

Instead of paying for the whole of a business loan spread out in a monthly-to-yearly plan, a business line of credit will allow you to recompense for the percentage you take out from it. You only need to pay for what you have borrowed, and it’s up to you to keep up the revolving line of credit so you can borrow again whenever necessary. It’s like a credit card in that you can simply pay the minimum due if your finances or earnings for a particular month are low.

For example, if you extract $1,000 from a $5,000, your repayment terms and contract will revolve around the $1000 amount. 

That being the case, you will have less of a burden to carry on paying back. And less of an interest rate to worry about as well, since said interest rate will be limited to the $1000 you have spent. 

3. Better Interest Rates Compared To Other Short-Term Loans 

Lines of credit are favored because, even though they are classified as “short-term loans,” the interest rates allocated to them are usually lower than those of other temporal lending and repayment status classifications, including an unsecured loan.

In fact, analysts have found that several business lines of credit have interest rates lower than those of standard credit card plans. This is to encourage entrepreneurs to be up to date with their repayments and on time.

Be sure to make timely repayments for you to let interest rates remain at their originally contracted numbers.

4. Fast Approval 

Traditional lenders, like banks, tend to be very strict about business loans regarding requirements, credit scores, and collaterals. A bad credit score can instantly terminate loan entry submissions. Not so with a business line of credit. Most lenders, including online lenders, are less draconian about approvals.

By the same token, lines of credit can be applied for and approved in as little as 24 hours, analyzing multiple lenders. Many factors, such as loan amount, business financial standing, minimum credit score, and online lenders and other lenders’ policies on reviewing business accounts, will affect this timeframe indefinitely.

Having said that, you may very well hear back about your loan application within the same day of submitting it. For example, fast approval is one of the key benefits of the best unsecured business loans.

5. A Better Way to Keep Track of Business Expenditures

With a line of credit, you are also provided with a better way to keep track of your expenditures as a business. Keeping your personal and business finances separate is easier since a business line of credit is wholly for your business and not for personal use. Every month, you can also easily see your expenses to understand better where your money goes.

6. A Smoother Running of Your Business Operations

Business credit lines are also helpful for other purposes – they allow you to run your business more smoothly. How so? Since you have a line of credit – cash that is basically available to you at any time – you can deal with emergencies when they come, such as unexpected expenses, the need to purchase more supplies, and so on.

So, you will be better at dealing with your business’s short-term needs, which will help you run your business’s daily operations without any distractions or disturbances.

7. Better Credit

As a business owner, you may already know how important it is to establish a good credit score rating with credit companies and agencies. By using a business line of credit and ensuring you pay what you borrow on time, you build a positive history regarding payments and credit for your business. If you ever need a term loan in the future, a good credit score rating or report can certainly be a big help.

8. More Options for Use

You will be given a lump sum when you get a standard, traditional business loan. You may already have a purpose for this lump sum: to expand, pay salaries, buy stock, etc. But once the loan money runs out and it turns out that you need to have repairs on your business premises, for example, then where can you get the cash you need?

This is where credit lines are beneficial because they allow you more options for use. You can turn to your line of credit as expenses and unexpected circumstances arise without worrying about the loan’s approval or how long it will take. The cash is immediate, and the problem is solved as it arises.

The Two Types of Business Credit Lines

You should also know that there are two essential types of business credit lines:

  • a secured line of credit and
  • unsecured line of credit.

Secured Line of Credit

A secured line of credit is a secured business loan where the lender asks you, as the borrower, to present some form of collateral (such as assets) against the credit. The good thing is that if you don’t have collateral, some lenders may be able to accept invoice accounts receivables or inventory instead.

Most lenders won’t necessarily ask for a big asset such as real estate or equipment, although there is still collateral. This is just a way for lenders to secure their investment.

Unsecured Line of Credit

However, the lender will not ask you for any collateral with an unsecured business loan or an unsecured business line. Since no collateral is involved, this is a more popular form of credit for many business owners.

Still, because the lender takes on more risk, you would need to undergo a more rigorous process before being approved for an unsecured business line.

For instance, to be approved, you may need to present a good rating for personal or business credit and evidence of steady revenue for your business. Unsecured lines of credit often have lower credit limits than secured ones, and the interest rates may be a bit higher.

With an unsecured business line of financing, business owners can draw funds as needed up to the approved limit, and interest is charged only on the amount borrowed, not the entire credit limit.

Small Business Loan vs. Line Of Credit: Which Is for You?

Whether you choose a business loan or line of credit, it is your responsibility as a borrower to research and weigh the pros and cons.

Term loans work best for long-term investments as they give you the ability to finance expenditures for long periods of time. Meanwhile, credit lines suit short-term financing needs, such as payroll and temporary cash flow shortages. While a line of credit can be renewed every one to two years, a term loan is fixed for the amortization period specified in your contract.

Once you have used the funds in your small business loan or grant, you must reapply for a new one. The money is reusable with credit lines until you reach the credit limit. You can also borrow only what you need.

Regarding interest rates, a term loan is typically higher than a credit line. Borrowers pay a fixed rate, unlike credit lines, where your interest rate increases once you miss payments or overshoot the cash limit. Term loans are also used for a specific purpose, while credit lines are more flexible.

In choosing between small business loans vs. line of credit, your decision should always depend on your business goals. You must also consider your tolerance for loan fees and how much you can pay monthly.

Are your cash needs long-term or short-term? Do you prefer a more flexible or fixed plan where payments and interest remain the same throughout?

Understanding the similarities and differences between a business loan and a line of credit will help you make the right choice for your business.

How to Qualify for a Business Line of Credit?

Let’s look at some universal requirements when it comes to secured and unsecured business line:

Time in business and

Lenders usually consider the length of time your business has been operating. Most require a minimum of 1-2 years in business. This shows that your business has a track record and is stable enough to handle credit.

Credit score requirements

Lenders consider personal FICO scores and business credit scores when reviewing loan applications. Typically, they require a minimum credit score of 500-600.

Collateral

Secured lines of credit require collateral to secure the loan. This can be equipment, real estate, inventory, or accounts receivable. Unsecured lines of credit do not require collateral but may have a stricter credit score and time in business requirements.

Annual revenue and cash flow considerations

Annual revenue is an important consideration in the application process. Lenders want to see evidence that your business has consistent annual revenue and can generate enough income to pay off the lines of credit. They may ask for bank statements or tax returns to prove your revenue.

So, business owners must have an open business bank account in good standing.

Financial history

Lenders review financial history, including income tax returns and banking documents.

A strong financial history can help business owners qualify for unsecured business loans, which do not require collateral but may come with stricter approval requirements.

Business plan

Some lenders may also ask for a detailed business plan outlining your company’s goals, strategies, and financial projections. This gives them an idea of your business model and how you plan to use the funds from the line of credit.

A detailed business plan explaining how the loan will be used can help lenders feel more confident about approving it.

Where to Get a Business Line of Credit

Online lenders offer faster funding speeds but may have higher interest rates. Traditional banks may have lower interest rates but a longer application process.

Researching and comparing different lenders is important to finding the best fit for your business needs. Before making a decision, look at each lender’s interest rates, terms, and requirements.

Before applying for a business line of credit, ensure you have all necessary documents, such as income tax returns and banking documents.

If you do not have a strong financial history or are just starting your business, consider applying for a secured line of credit with collateral such as equipment or inventory. This can help you secure a lower interest rate and increase your chances of approval.

Additionally, building a positive credit history by consistently paying off credit cards and loans on time can also improve your chances of getting approved for a business line of credit.