Business Loans

Line of Credit: The Complete Guide

Jun 03, 2022 • 10+ min read
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      Business lines of credit are a form of revolving credit offered by financiers—both traditional lenders like banks and alternative financiers that live online.

      Business lines of credit serve as lifesavers for many small businesses, especially seasonal ones where you have to spend a lot to prepare for a busy season. However, they are used by small businesses of all kinds as a way to support expansion. Overall, it is always best to view financing as a path to grow your business instead of a way to dig yourself out of a hole.

      In this guide, we will explore how business lines of credit work, what you need to qualify, potential alternatives, and why your business should access one.

      What is a Line of Credit?

      A business line of credit is a financing tool for businesses that allows them access to money as expenses arise.

      They are more similar to a business credit card than a business loan because you don’t receive a lump disbursement at once. Instead, you pay for business expenses using the line of credit and repay the financier back for only the funds used.

      If you pay using a line of credit, interest accrues on any balance that is not paid down by the end of each statement period. Like a credit card, as you pay down the balance, the amount of credit available to you increases.

      Limits on a business line of credit are set by a lender. Lines of credit are typically renewed over time, assuming the borrower’s creditworthiness remains in good standing. Usually, once you agree to a line of credit, it will remain open until you opt to close it.

      While business lines of credit and credit cards function in similar ways, there are key differences between them:

      • Business credit cards are built for common one-off purchases like office supplies and travel expenses. Business lines of credit are good for larger or recurring expenses, like rent or bills from vendors. Many landlords, for example, won’t accept credit cards but will accept funds from a line of credit.
      • Business lines of credit usually have maximum credit limits that are much bigger than credit cards, so they are suitable for more expensive purchases, especially recurring ones.
      • Approval for a business line of credit takes longer than credit cards, sometimes 1 or 2 weeks. In some situations, credit card applications can be approved almost immediately.
      • Interest rates for lines of credit tend to be lower than for credit cards. As of May 2022, interest rates for lines of credit can be as low as 8%. Interest rates for credit cards are often between 10% and 20%, although many have introductory offers with 0% APR. Importantly, interest rates for small business loans, especially term loans, are usually lower than lines of credit.

      As an example, imagine you operate a small consulting business out of your home. If most of your expenses aren’t recurring, like the occasional purchase of a new computer or printer paper, a credit card would probably be the best fit.

      On the other hand, you might be facing large, recurring expenses, like the sudden need to pay for several independent contractors to handle some of the workload. In this situation, a business line of credit would be the much smarter choice.

      Line of credit vs credit cards: the difference

      While business lines of credit and credit cards function in similar ways, there are key differences between them:

      • Business credit cards are built for common one-off purchases like office supplies and travel expenses. Business lines of credit are good for larger or recurring expenses, like rent or bills from vendors. Many landlords, for example, won’t accept credit cards but will accept funds from a line of credit.
      • Business lines of credit usually have maximum credit limits that are much bigger than credit cards, so they are suitable for more expensive purchases, especially recurring ones.
      • Approval for a business line of credit takes longer than credit cards, sometimes 1 or 2 weeks. In some situations, credit card applications can be approved almost immediately.
      • Interest rates for lines of credit tend to be lower than for credit cards. As of May 2022, interest rates for lines of credit can be as low as 8%. Interest rates for credit cards are often between 10% and 20%, although many have introductory offers with 0% APR. Importantly, interest rates for small business loans, especially term loans, are usually lower than lines of credit.

      As an example, imagine you operate a small consulting business out of your home. If most of your expenses aren’t recurring, like the occasional purchase of a new computer or printer paper, a credit card would probably be the best fit.

      On the other hand, you might be facing large, recurring expenses, like the sudden need to pay for several independent contractors to handle some of the workload. In this situation, a business line of credit would be the much smarter choice.

      Business Line of Credit Advantages

      • Revolving access to credit, usually without the need for collateral
      • Credit limits much higher than credit cards
      • Interest rates typically lower than credit cards

      Business Credit Card Advantages

      • Great for smaller one-off purchases
      • Application approval processing time usually much quicker than lines of credit

      Credit cards are more likely to offer 0% APR or other introductory bonuses than business lines of credit 

      Types of Lines of Credit

      Business lines of credit can be secured or unsecured. This difference revolves around the question of collateral.

      A secured line of credit requires the borrower to put up cash or assets that act as collateral in case they default on the loan. Unsecured lines of credit do not require collateral.

      Unsecured lines of credit are much more common than secured lines of credit. However, if your business is a startup or you have a suboptimal credit history, a secured line of credit might be easier to get approval for.

      Furthermore, if your business requires access to a larger line of credit, as in greater than $100,000, a financier might require a secured line of credit agreement. 

      Unsecured Line of Credit

      Secured Line of Credit

      No collateral required

      Collateral, in form of cash or assets, required to sign line of credit agreement
      Usually have credit limits below $100,000

      Usually for lines of credit of $100,000 or more

      How Does a Line of Credit Work?

      Once you receive approval for a line of credit and agree to the financier’s terms, the mechanics of a business line of credit are pretty easy to understand.

      You can use the funds from the line of credit for any business-related expenses—you can even withdraw them as cash to use for business purchases.

      If you don’t repay the financier for any funds used within a statement period, your account will accrue interest.

      Generally, you don’t want to spend too close to your credit limit for too long—this situation sends a warning to your lender that your business might be struggling.

      In some cases, a financier might require you to pay down your total balance and keep your balance at $0 for a period of time. This shows that your business can survive without using credit.

      In other situations, especially in a bad economic environment, a financier might require you to pay back a line of credit all at once. Because of this, you shouldn’t make a line of credit the lifeblood of your company.

      Pros and Cons of a Line of Credit

      A business line of credit is ideal for smaller companies that have been established for at least a year, especially ones that are strongly impacted by seasonal trends.

      With these types of businesses, you need to spend money to prepare for an upcoming busy season. However, ahead of the busy season, you might not have any revenue coming in if you own a startup in an early stage. In this situation, a line of credit is ideal.

      However, a line of credit can be great for any business that needs a cash cushion as it grows.

      Business Line of Credit Benefits

      • Revolving access to credit, often without a collateral requirement
      • Higher credit limit than other unsecured forms of lending, like credit cards
      • Interest rates usually lower than credit cards or short-term loans

      Business Line of Credit Risks

      • Approval processing time usually longer than with credit cards

      Financier might require line of credit to be completely paid down for a period of time each year 

      Business Line of Credit Rates

      Interest rates for a business line of credit can range from 8% to 24% as of May 2022. If your credit score is higher, you can usually secure a rate on the lower end of this scale.

      Remember, these interest rates only apply to balances that carry over from repayment period to repayment period. You’ll pay the least amount of interest if you can pay down your balance as quickly as possible.

      It is common for lines of credit to have annual fees, so read your agreement carefully.

      Generally, you don’t want your balance to be too near your credit limit for too long, especially if you work in a riskier industry like restaurants, construction, or seasonal retail.

      Research is always your friend when it comes to small business financing. You can use line of credit calculator to understand exactly what a line of credit could provide for your company.

      Apply for a Business Line of Credit

      You can apply for a business line of credit via Lendio right now and see your options in seconds. Lendio works with over 75 financiers so that small business owners can easily compare their choices in one place. Even better, working with Lendio’s application is free and won’t hurt your credit score because no hard pull is required to see what is available.

      Lines of credit provide flexibility in an ever changing business landscape—think about how you can leverage one to take your company to its next level.

       

      Disclaimer: The views and opinions expressed in this blog are those of the authors and do not necessarily reflect the official policy or position of Lendio. Any content provided by our authors are of their opinion and are not intended to malign any religion, ethnic group, club, organization, company, individual or anyone or anything. The information provided in this post does not, and is not intended to, constitute business, legal, tax, or accounting advice and is provided for general informational purposes only. Readers should contact their attorney, business advisor, or tax advisor to obtain advice on any particular matter.
      About the author
      Barry Eitel

           

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