Guide To Getting A Business Line Of Credit For Small Businesses
If you are a business owner who has struggled to pay bills or missed out on an opportunity to grow your business due to lack of capital, you know just how frustrating cash flow problems can be.
A business line of credit is a potential solution for cash flow problems.
This type of small business financing can be used for solving cash flow problems, capitalizing on business opportunities, or having an emergency fund ready to go. When you have been approved for a line of credit, you can draw from your available funds at any time, for any reason.
What is a line of credit? Is it right for your business? And how do you get one? Find out below.
Table of Contents
- What Is A Business Line Of Credit?
- How Business Lines Of Credit Work
- Business Lines Of Credit VS Business Term Loans
- Business Lines Of Credit VS Credit Cards
- Should You Get A Business Line Of Credit?
- How To Get A Business Line Of Credit
- FAQs About Business Lines Of Credit
- Final Thoughts On Business Lines Of Credit
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.
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 differs from the most common type because it is secured by collateral. The value of the collateral determines the amount of credit you will have access to.
Acceptable assets will vary from lender to lender, but can include assets like:
- Your accounts receivable
- 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 then 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 an 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. In 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.
Why would you want a business loan over a business line of credit?
- 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.
Why would you want a business line of credit over a business term loan?
- 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 a savvy credit cardholder 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.
Why would you want a credit card over a business line of credit?
- 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.
Why would you want a business line of credit over a credit card?
- 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, consider a different product.
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.
Step One: Decide What Type Of Business Line Of Credit You Need
There are multiple types of credit lines. Each is designed for different business purposes. You might want to consider the following common lines of credit:
- Revolving line of credit: A credit line in which the amount you can borrow becomes available as you repay outstanding loans.
- Asset-backed line of credit: A line of credit secured by collateral such as accounts receivable, inventory, or equipment.
- Home equity line of credit (HELOC): A line of credit secured by your home equity. HELOCs are a good option for startups.
- Business credit card: A line of credit used to purchase goods and services.
Step Two: Assess Your Borrowing Health
Lines of credit are often harder to get than a traditional term loan.
You can narrow down your search and save yourself time by assessing yourself as a borrower. Lenders will be looking at factors such as:
- Your credit score
- How long you’ve been in business
- Your business revenue
- Available collateral
- Recent bankruptcies
Learn more about how to assess your borrowing health in our guide The 5 Cs Of Credit: What Lenders Look For.
Step Three: Look For Business Line Of Credit Lenders
Once you have a sense of your borrowing health, you can get a better understanding of where you should focus your search for a lender. A wide variety of lenders offer lines of credit, including:
- Online lenders
- Credit card issuers
- The Small Business Administration (SBA)
Step Four: Complete Applications
To get a line of credit, you will, of course, have to fill out an application. What your application will look like will vary depending on the type of line of credit you’re applying for and the lender you’ve selected.
Many line of credit lenders offer online applications. However, you might have to go to a physical location depending on the lender you are working with.
Common documents you might have to supply during the application include:
- Basic information about your business
- Business and personal tax returns
- Bank statements
- Personal ID
- Balance sheets
FAQs About Business Lines Of Credit
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 the Best Line Of Credit Options For Small Businesses.