business line of credit

What Is a Business Line of Credit? The Complete Guide

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Do you need immediate access to financing? Perhaps you don’t qualify for a business loan.

Instead, consider a business line of credit.

What is a line of credit?

A line of credit for businesses allows you to draw a fixed amount of capital when you need it. A credit line allows you to finance short-term endeavors, and you only pay back the amount you borrow. 

You can use the credit line to expand your business. Overall, it’s a financial cushion when you need it most. 

This article will show you how a small business line of credit can enhance your business. Let’s explore. 

Types of Business Credit 

There are two types of business credit lines: secured and unsecured. An unsecured line of credit requires no collateral.

This means lenders don’t require you to pledge some of your assets to secure the loan. However, there are some drawbacks, such as:

  1. You usually need a stronger credit score to qualify for an unsecured loan.
  2. The credit lines may be smaller.
  3. The lender could impose a higher interest rate.

A lender could have stricter standards for unsecured loans due to the riskiness of lending without collateral. Conversely, a secured credit line requires assets.

Owners can usually pledge inventory or accounts receivable as collateral. If you fail to repay the loan, the lender can seize all assets that you pledge.

Secure lines of credit, however, are more likely to have lower interest rates. Also, lenders could give you more funds because the collateral decreases the lending risk.

How Lines of Credit Work

A line of credit for small businesses differs from a business loan. Credit lines allow you to keep borrowing and repaying the funds. Business credit lines are similar to personal credit lines.

The lender will approve a certain amount of spending money. The amount provided depends on a variety of factors, such as your credit history and/or business income. 

With business term loans, you’ll get a set amount of money upfront. From there, you must pay back the loan within a certain timeframe.

On the other hand, there are two main rules when it comes to credit lines:

  1. Repay the money in a timely fashion.
  2. Don’t borrow over the credit limit.

As such, credit lines are more flexible than term loans. Additionally, you don’t pay interest on the entire credit line. You only pay interest on the amount you take out. Further, you don’t have to worry about early payment fees.  

Line of Credit Qualifications

The standards depend on the lender. Overall, many types of businesses can obtain a credit line. Perhaps you own a starting enterprise. Conversely, you may have been in business for years.

Regardless, lenders will generally assess the following when viewing your application:

  • Time in business: A lender may require that businesses have a minimum two-year history. For other lenders, they may require less time. Some lenders cater specifically to start-up enterprises. 
  • Business debt-to-income ratio: You could face hurdles if your business carries too much debt. If you have many debts, consider refinancing or repaying the debts before applying for a credit line. 
  • Annual business revenue: As a general rule, many lenders prefer an annual business revenue of at least $50,000. However, other lenders may require less revenue. Conventional lenders may require $100,000 or more annually.  
  • Industry type: Lenders view certain industries as safer bets than others. For instance, they generally see real estate or retail as riskier industries. With that, you can find lenders willing to lend in riskier industries. 
  • Personal credit profile: Lenders usually check personal credit scores because they want to see if you can personally guarantee repayment of the credit line. Bad credit doesn’t necessarily mean you’ll face rejection. The problem is that your options may be limited. 
  • Business credit profile: If you don’t have a business score, lenders will default to your personal score instead. Lenders also use business scores to assess your risk level. 

Overall, lenders will assess the risk factor involved. If they deem your business high risk, you could pay a higher interest rate or receive less than you requested. In other cases, they could deny your application. 

Some lenders are more lenient than others. In particular, online lenders are usually less stringent than conventional lenders. Therefore, shop around for the best deal available.

Regardless, choose a reputable lender who will give you a fair deal. Too often, disreputable lenders charge exorbitant interest rates, increasing the risk of default.

When to Apply for a Business Line of Credit

Many companies use business credit lines to expand their operations. 

  • Example: You can use credit lines to expand your marketing budget and reach new customers. From there, you can pay off the borrowed money as you gain new customers. 

In other cases, your business may need a lifeline until you receive payment from your clients. Since many clients make late payments, credit lines can keep you afloat until they pay you.

Further, other owners use lines of credit if their business falls on hard times. They can borrow small amounts of money that fit within their budgets, with no need to pay interest on the entire credit line. 

Is a Business Line of Credit Right for My Business? 

Above all, a business line of credit can help your business in the short-term. You only need to pay back the amount you spend.

The standards can vary, but you’ll have better luck qualifying through an online lender. Be aware, however, that some lenders require collateral before approving your request. 

Do you need to improve your credit score? Click here to learn how we can help. 

 

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