Business Line of Credit: How It Works and Choosing the Best Option
Many businesses face the need for financing at some point during their lifecycle, but the reasons and options for doing so vary greatly from company to company.
Businesses that seek out funding for a large project or a fixed major expense may benefit from a business loan, as it provides a one-time amount with a predictable repayment term. However, some businesses may find the flexibility of a business credit line optimal for their ongoing financing needs.
Before applying for one versus the other, it’s helpful for business owners to understand what a business line of credit is, how to get one, and the options for borrowing via a line of credit.
What is a Business Line of Credit?
A business line of credit can be compared to a personal credit line, where a lender offers flexible access to funds on an ongoing basis. A business line of credit has a stated credit line maximum that businesses can borrow against and pay back over time.
As a revolving account, similar to a credit card, there is no set monthly payment for some credit lines. Instead, there’s a minimum payment of principal, interest, or a combination of the two based on the amount borrowed. As payments are made on the outstanding balance, the available credit increases up to the stated maximum.
A business line of credit works best for businesses that are in need of flexible, ongoing access to financing. For example, a business owner may use a business credit line for funding payroll or overhead expenses during a seasonal slump, or for a major expense that comes out of the blue. Unlike a loan that offers a fixed lump sum amount and steady repayment over a set number of months or years, a business line of credit allows business owners to just use the funding they need – and when they need it.
Although the flexibility is helpful, business lines of credit can be more expensive in terms of the interest rate than traditional fixed loans. Business owners with a large credit line may also run into trouble if they borrow too much and only make minimum payments over time.
How to Get a Business Line of Credit
Compared to small business loans, a business line of credit is easier to qualify for, and it often does not require collateral like a building or equipment to secure the credit line. However, business owners must still submit an application to a lender that details the business revenue, time in operation, and assets on hand to get approval. The stronger the business and in some cases, personal financial data and credit history, the higher the probability of getting approved for a new business line of credit.
It is important to recognize that business lines of credit have higher interest rates than business loans, which helps offset some of the risk lenders take on in granting approvals to a business with less than perfect financial records or revenue history. That means it might be easier to meet the requirements for a line of credit, but the cost could be far higher than a traditional business loan.
What Are Your Options for a Business Line of Credit?
Many lenders, both conventional and online, offer qualified businesses access to lines of credit when they need financing. Companies like Fundbox, StreetShares, and OnDeck all offer short-term lines of credit for businesses, ranging from $1,000 up to $100,000.
Traditional banks and credit unions may also offer long-term business lines of credit for the most qualified applicants, and in some cases, with higher credit lines. Businesses typically need at least six months in operations to qualify for an online credit line lender, and two years for a bank or credit union lender.
When evaluating business line of credit lenders, pay attention to the cost of borrowing combined with the repayment term. Interest rates range from 9 percent to 40 percent, with the latter having a substantial impact on the total cost of borrowing.
Repayment terms may range from three months up to three years, depending on the size of the credit line and the needs of the business. Be sure to ask the lender these specifics before signing on the dotted line. This ensures the credit line won’t be more burdensome in terms of cost and repayment than it is beneficial.
A Business Line of Credit vs. a Business Credit Card
Although it might sound like a business line of credit and a business credit card are one in the same, there are subtle differences that should be recognized. Lines of credit can be offered as secured, meaning backed by collateral, or unsecured, while business credit cards are almost always unsecured.
Because of this difference, interest rates on business credit cards are typically higher than comparable lines of credit. Also, business lines of credit do not typically offer rewards or incentives like business credit cards might.
Business owners who want lower-cost financing might look to lines of credit first, especially when the need for funds is substantial. Alternatively, business credit cards are better used for business owners who want to maximize their spending each month via rewards programs, or when financing needs are relatively small.