If you are a business owner, a company credit line is a great way to access short-term funds for business expenses. Especially if you have fluctuating demand, seasonal expenses or customers paying via installments.
In this informative guide, we'll review the way it operates of a business line of credit and provide you with the necessary steps to try to get one.
What Is a Business Line of Credit and just how Do you use it?
A business line of credit is a kind of loan that functions a lot more like credit cards (aka revolving credit). Borrowers get a credit line from the lender having a set borrowing limit. You should use your credit line for any business-related purchase or investment as much as your credit limit. Similar to a credit card, the loan you use becomes unavailable before you pay it back.
Unlike charge cards, a credit line has a lender draw period, the time period limit for withdrawing money.
Draw periods usually vary from 1 – Five years and vary by lender. Each month during the draw period, you are only required to spend the money for interest on which you've borrowed. It's not necessary to reduce your balance yet – unless you want to. However, should you borrow your entire credit limit, you will have to pay toward balance in order to borrow again.
When the draw period ends, the borrowed funds enters repayment as well as your window to withdraw funds closes. At this point, you continue making your monthly obligations – which are now comprised of the accrued interest and the loan's principal balance – until the loan pays off. This payment term may have an expiration date at which the road of credit will be closed.
Unsecured vs. Secured business line of credit
An unsecured credit line is a loan that does not require collateral. That said, a lender may still require you to sign an individual guarantee or a blanket lien. This ensures the signer continues to make payments around the debt (even if the business can't), or grants access to collateral, should the business default. Since lenders assume more risk with unsecured lines of credit than secured ones, rates of interest are often higher.
Conversely, a secured line of credit requires collateral, which provides the lender with protection should you default on the loan. Collateral is one thing of worth the lending company may take possession of and sell to recoup losses from a default. The type of collateral will depend on the lender's requirements but could be everything from equipment or inventory to bank accounts.
Most of the time, business credit lines are offered as personal debt. But if you are taking out a higher line of credit, a lender may require it to be secured.
Business credit line vs. Business loan
While a company credit line is a kind of loan, it's not to become wrongly identified as a business loan. Having a business loan, you obtain the money in a lump sum and pay it back (plus interest) on the fixed schedule. Once you receive the money, interest starts to accrue and the amount of interest you have to pay is based on the full amount of the borrowed funds.
With a business line of credit, you have access to funds when you need them, and also you pay only interest on which you withdraw, not the whole credit line.
However, interest rates on loans are often lower than those on a line of credit. This can make budgeting with loans easier, especially if you are a small business.
Benefits of the Business Line of Credit
A business credit line is great for businesses that need access to capital but don't need it all upfront.
Here are some more benefits of a company line of credit:
- Flexibility: A line of credit provides more flexibility than a loan. You can access the funds when you really need them and continue borrowing as long as you pay down that which you use and continue making monthly payments.
- Quick turnaround: You might be capable of getting a credit line faster than the usual business loan. Sometimes in as little as one day.
- Only pay interest on purchases: You pay only interest around the money you withdraw, so there is less pressure you to invest the whole amount than there is having a business loan.
- Build credit: Getting a line of credit can help you build business credit whenever you keep it in check responsibly and make your instalments on time, which can help future you secure a better loan.
If you're focusing on a lengthy project with variable expenses, it might be preferable to obtain a credit line than a business loan. Or maybe you're working on a task that needs access to larger funds, it might make more sense to obtain a credit line than the usual business credit card.
What To think about Before Applying
Getting a business credit line makes sense when your business includes a healthy cash flow but needs short-term financing. However, taking on more debt may not be a good idea if you are struggling financially.
So prior to applying for a company line of credit, there are a couple of things you will want to consider.
Interest rates
Interest rates on a business line of credit can be fixed or variable depending on the lender and kind of loan. Rates of interest on a line of credit are often higher than those found on loans but can be lower than a company credit card.
Higher business credit scores boost the likelihood of favorable interest rates.
Fees
Credit lines come with many fees and they can differ between lenders. So make sure you read the loans. Here are some a few of the fees you might encounter:
- Draw fee: Charged whenever you withdraw from your line of credit (usually based on how much you withdraw)
- Late fee: Charged when you create a late payment
- Maintenance fee: Charged either monthly or annually (keeps your line of credit active)
- Inactivity fee: Charged if you do not use your line of credit for any set length of time
- Payment processing fee: Charged to process transactions in your credit line (different from a draw fee, and you'll encounter both)
- Termination fee: Charged should you close your line of credit before the expiration date
- Prepayment fee: Charged should you repay your withdrawn amount ahead of schedule
Taking these considerations into account before you apply for a line of credit can help you make the best decision for your business while you start the applying process.
Explore and Compare Your Lender Options
Before you start exploring your choices, estimate how much cash you have to borrow so that you can search for credit lines that match or exceed your needs. Just remember to make use of your credit responsibly should you obtain a higher borrowing limit than you currently need! Should you wind up needing a lot more than your initial borrowing limit later on, you may be able to ask your lender for a credit line increase.
Once you possess an estimate of methods much you'll need, you can start searching for lenders that offer that credit limit, such as banks, credit unions and online lenders.
However, due to lender requirements, it might be harder for a newer business to obtain a business credit line (more about requirements later). Online lenders might be more prepared to work with riskier or newer borrowers, which could mean less favorable loan terms.
Shopping around will help you compare annual percentage rates (APRs), repayment terms and draw periods. Understanding the requirements will help you pick which credit lines you may qualify for.
Confirm Your Eligibility
Check the road of credit you want to make an application for to ensure that you meet the specific requirements, as they will vary by lender and type of loan. The three main requirements lenders consider for any business line of credit are time in business, revenue and credit history. This means that small businesses do not need to fear because the size of the company doesn't usually matter.
Time in business
Some lenders have a minimum requirement of just how long your company continues to be operating. Most require you to be in business for at least Six months or perhaps a year, but it could be longer. The more you have been running a business, the greater stable your business looks to lenders and the much more likely they may be to approve the application.
Revenue
Lenders may have a minimum revenue requirement. You may find that online lenders tight on strict requirements than traditional banks or lending institutions. Some lenders will have small company line of credit options for individuals with lower revenue.
Credit history
Your qualification is heavily determined by your credit history. If your clients are new or includes a thin credit history, a lender may consider both your business and private credit history. So you will want to check your personal credit rating too. Lenders will typically locate a credit score around the high 600s, however, many lenders will work with businesses and people that have bad credit.
Prepare and Submit Your Application
The information necessary for each business line of credit application will vary by lender. If you want to accelerate the applying process, contact prospective lenders to discover their specific requirements.
Here are the things you will need during the application process:
- Legal business name, address, phone number and tax identification number (aka EIN)
- Personal income, Social Security number and date of birth
- Type of economic structure (corporation, nonprofit, sole proprietorship, etc.) and business industry
- Years in business and quantity of employees
- Financial and tax statements (both business and personal), profit and loss statements and annual revenue
- Estimated monthly business expenses
Check the application thoroughly before submitting, as errors may cause a delay in receiving your funds. As you prepare, submit your application. Now the wait begins! You could get an approval notice right away, or it might take a few days. This will vary by lender. The lender may also request you to submit additional documents before they decide to approve the application.
Once approved, the lending company will send you a loan agreement to sign before issuing the credit line.
You're in Business Now
A business credit line is a great option to fund larger, short-term expenses you will possibly not have the ability to fund having a business charge card. It's also more flexible than the usual business loan.
The application and qualifications vary by lender, so make sure you read the requirements carefully while you stick to the steps we've outlined.
