Guide To Getting A Business Line Of Credit For Small Businesses

What is a line of credit, and why do you need one for your business? A business line of credit is a potential solution for cash flow problems. A line of credit can help you capitalize on business opportunities or can help with an emergency or unexpected expense.

Ready to learn more? Keep reading to find out what a business line of credit is, how it works, and if it’s right for your business.

What Is A Business Line Of Credit?

A business line of credit is a type of financing similar to a credit card. When approved, the borrower has access to a set amount of cash from which they can draw at any time. The borrower can pull from their available funds as long as they don’t exceed the borrowing limit.

Business owners often get a line of credit when:

• They have inconsistent cash flow
• They have a seasonal business and need financing during the off-season
• They need to pay for supplies and inventory
• They want an emergency fund
• They are paying for a project but don’t know how much it will cost

A line of credit is a good choice for businesses that need cash fast. When you are approved for a credit line, you can draw from your available credit at any time — no application required.

How Business Lines Of Credit Work

Business lines of credit are similar to credit cards.

Rather than receiving a single lump sum, as you might with a traditional loan, borrowers with a line of credit have access to a credit line from which they can borrow at any time.

You can draw on that line of credit in whatever increments you desire, so long as the total amount you’ve borrowed is less than or equal to your credit limit.

While it appears simple on the surface, the loan can become a little more complicated in practice. Lines of credit come in a variety of forms with variations in terms of their duration, grace periods, interest, draw fees (if any), and security. Make sure you fully understand the terms of your specific line of credit before accepting an offer.

Learn about how specific types of lines of credit work below.

Revolving VS Non-Revolving Lines Of Credit

Most lines of credit are revolving. If you have a revolving line of credit, you will be able to re-borrow cash after you have repaid your debts.

For example, if you have a credit limit of $5,000 and borrow $500, you have $4,500 remaining. If you repay the $500 you borrowed, you will have $5,000 to draw on again.

If you have a non-revolving line of credit, you will not re-gain access to the money when its repaid. You can draw as much or as little as you want from your credit line, but as soon as you have borrowed the maximum amount, your credit line will be closed.

Asset-Backed Business Lines Of Credit

An asset-backed business line of credit is different from other lines of credit because it is secured by collateral. The value of the collateral determines the amount of credit you will have access to.

Acceptable assets vary from lender to lender, but can include things like:

• Your accounts receivable
• Inventory
• Equipment
• Bank accounts

Why would you go for this kind of line of credit? Collateral reduces the risk to your lender. In exchange, you can borrow with better rates and terms than you would be able to otherwise.

Interest-Only Grace Periods

Some lines of credit come with an interest-only grace period, notably the ever-popular home equity line of credit (HELOC).

If your line of credit has a grace period, you only have to make interest payments for the length of the period. You do not have to pay down the principal. Grace periods typically run from six months to one year. During this time, you can draw from your credit line as needed.

In many cases, when the grace period ends, you will no longer be able to draw on your line of credit. At that point, it effectively functions as a traditional loan.

Business Lines Of Credit VS Business Term Loans

Business term loans come in a number of different forms, but all are received via a single lump sum. After receiving your money, you typically have to begin repaying the loan immediately. Like business lines of credit, business loans are meant to be used for specific business-related expenses.

Whether you choose a line of credit or a term loan depends on a number of factors.

When To Choose A Business Term Loan

• They’re (usually) easier to qualify for.
• The rates can be better than a similar line of credit.
• You know exactly how much money you need.
• You want a predictable repayment schedule.

When To Choose A Business Line Of Credit

• You need some “insurance” against upcoming expenses.
• You don’t know how much money you’ll need to borrow.
• You want to smooth out your company’s cash flow.
• You want flexibility.

Business Lines Of Credit VS Credit Cards

Credit cards are optimized for point of sale transactions — you swipe them and you’ve made the purchase. What credit cards aren’t good for is getting cash directly into your hands when you need it.

In fact, cash advance rates for credit cards are really dismal, and one of the worst ways to use your credit card.

Business lines of credit, on the other hand, are a relatively inexpensive way to infuse your company with cash on short notice.

Credit cards come with an interest-free grace period every month, so savvy credit cardholders can avoid ever paying interest on their credit card purchases. The flip side of this is that any balance you carry on your credit card will be subject to high-interest rates.

When To Choose A Credit Card

• You want convenience when making retail purchases.
• You want to take advantage of credit card rewards programs.
• You make purchases you can pay off quickly.
• You want the insurance perks that come with using a credit card.

When To Choose A Line Of Credit

• You need cash on demand.
• You need to carry a balance month-to-month.
• You need a higher credit limit.

Note that some lenders offer lines of credit that allow you to tap them with a credit card. Some of these products even have reward programs. Just make sure you know for sure what type of product you’re working with so you can use it optimally.

Should You Get A Business Line Of Credit?

A business line of credit offers a wealth of advantages to borrowers, but that doesn’t mean they’re a great fit for every company.

Line Of Credit Advantages

• Money when you need it: When an unexpected expense hits you, you don’t have to search between your couch cushions for loose change or take out a high-interest short-term loan to cover the gap.
• Peace of mind: Having a backup account to cover expenses can do a lot to help you operate with confidence.
• More credit for your effort: Since a revolving line of credit can be reused, you’re potentially getting a lot of capital for the effort you put into your application.

Line Of Credit Disadvantages

• Fees: Annual fees, draw fees, and interest payments can add up over time. If you don’t see yourself using your line of credit in the near term, it may end up being an unnecessary expense.
• Easily abused: If you’re a spendthrift, having a deep well of credit to draw from might encourage your bad habits.
• Other financing might be a better option: As we touched on earlier, there might be a better tool for the job than a business line of credit. If you just need a one-time cash infusion or need to make frequent, smaller retail purchases, you might consider other financing options.

How To Get A Business Line Of Credit

Think that a business line of credit is the right choice for your small business? Learn how to get a line of credit step-by-step.

Final Thoughts On Business Lines Of Credit

If your business could benefit from a financial safety net, a line of credit might be a very convenient way to overcome rough times.

Due to the nature of the loan, if you’re considering a line of credit, don’t put it off. Lines of credit are only useful if you have access to one when the need arises. Give yourself enough time to compare options before settling on a line of credit.

Ready to start looking for a small business line of credit? Head over to our article on the best line of credit options for small businesses.

FAQs About Business Lines Of Credit