Is a Business Line of Credit a Good Idea?

If your business is struggling to make ends meet, a business line of credit may be the right solution. Similar to the way a credit card works, a business line of credit allows you to borrow funds up to a certain amount and pay interest on only the money you borrow. After repaying the funds, you can continue withdrawing more money on the line.

“A business line of credit can be crucial to help a business take advantage of an opportunity or weather a crisis,” says Gerri Detweiler, former education director for Nav, a business credit and financing resource. “It allows you to borrow only what you need, up to your credit limit, and only pay interest on the money you have borrowed.”

As long as you can qualify and use the line of credit judiciously, it can be one of the best tools available to your business.

What Is a Business Line of Credit?

A business line of credit provides your company with a fixed amount of money you can use for short-term operating expenses, such as paying suppliers or meeting payroll. You are free to use as much money as you need up to your limit, and the portion you borrow is considered a loan.

As you pay back what you’ve borrowed, a revolving business credit line lets you borrow more cash without having to apply for another line of credit. If you make at least minimum payments and stay under your limit, you can use your credit line for as long as permitted under your lender’s terms.

You’ll find that some lines of credit are unsecured, while others are secured with assets the lender can claim if you fail to pay as agreed.

Lenders may expect payments weekly or monthly, and payoff time frames can range from a few months to several years. Your payments can fluctuate based on the amount you borrow.

Interest applies only to the amount you borrow. If your credit line is $100,000 and you withdraw $20,000, the untapped portion of $80,000 won’t incur interest.

That doesn’t mean business credit lines are free, of course. You could pay origination, maintenance or draw fees, for example, as you open and use your account.

You can transfer funds from your credit line to your checking or savings account by phone or online, or with a debit card or checks from your lender. ATM transactions could trigger fees, however.

If you think these lines of credit sound like credit cards, you are right. The key difference between the two is that business lines of credit tend to have significantly higher limits than credit cards.

Should You Get a Business Loan or Line of Credit?

Whether a business loan or line of credit is right for you depends on your circumstances.

Business loans: A business loan can be a good choice for planned expenses, such as financing equipment.

When you take out a loan, you’re borrowing all the money at once and typically paying it off over several years.

Business lines of credit: They are meant for business expenditures that you will repay within months or a few years. A business line of credit is better in uncertain times, such as when you might struggle to predict revenue and expenses.

But keep in mind that lines of credit are more likely to have variable interest rates, and if you miss a payment, your interest rate could rise. You could also pay more if you choose an online lender rather than a traditional one.

Interest rates with online lenders can be higher than at your local bank or credit union, says Brooke Lively, president and founder of Cathedral Capital, which provides chief financial officer services for small businesses. “And many of these loans don’t have the benefit of prepayment – meaning that it doesn’t matter if you repay the loan early,” Lively says. “You will have to pay the full amount of the interest.”

The advantages of business credit lines with these lenders: Applications are usually fairly straightforward, you get a decision in minutes and funding can happen within 24 hours, she says.

How Do You Qualify for a Business Line of Credit?

Qualifications for business lines of credit vary by lender. Most lenders need to know not only basic details about your company – type of business, legal structure and ownership – but also earnings, financial statements and tax returns. Other specifics will depend on whether you apply for a business line of credit with a traditional bank, a credit union or an alternative lender.

For a secured business line of credit, Bank of America requires at least two years in business under the present ownership and at least $250,000 in annual revenue. A credit union will ask you to first become a member, usually by opening a deposit account, and then meet its distinct requirements for a business line of credit. An alternative lender typically expects you to be in business for a minimum of six months, with at least $50,000 in annual revenue.

If you’re interested in a Small Business Administration CAPLines loan to meet short-term or cyclical capital needs, the SBA provides a thorough submission checklist. Businesses must meet 7(a) loan program standards, plus requirements for the desired CAPLines loan.

Regardless of what you choose, the lender will pull your credit reports to see how you’ve managed credit and to understand your debt load. If you’re checking rates with several lenders on the same type of loan, this should have little effect on your credit score.

You should learn the status of your application within minutes if you choose an alternative lender. Other lenders could take days or weeks to decide because they dig deeper into your financials.

If you apply but do not qualify for a line of credit, your credit scores may be too low, your business too new, your loan size too big or your industry too risky, Detweiler says.

Where Can You Get a Business Line of Credit?

Many financial institutions issue business lines of credit, from large commercial banks to local lenders and credit unions.

“If you can qualify for a line of credit through your bank or credit union, that’s likely to be the lowest-cost option,” Detweiler says. “You can also try a credit union or community bank, or even a Community Development Financial Institution.”

Another option is online lenders such as Kabbage or OnDeck. These alternative lenders may appeal to firms classified as medium or high credit risk that have been in business for no more than five years.

Although approval could be easier with alternative lenders compared with traditional financial institutions, the former could charge you more in interest to account for risk. Still, some business owners are willing to accept the higher rate for instant access to necessary funds.

When Theo Lee needed startup capital for Korean food brand KPOP Foods, he chose a business line of credit from Kabbage.

“We needed additional capital to hold us over during our equity crowdfunding campaign, so the total amount needed had to be over $15,000,” says the CEO and co-founder of the Los Angeles company. “The interest rate was important, but not necessarily the most important thing.”

If you opt for an online lender, you can usually expect faster decisions than traditional banks, Detweiler says. Online lenders might also check your credit by reviewing activity in your business bank account, as well as your personal credit, she adds.

“Online lenders often charge higher costs, though, so you want to make sure you understand the cost and how it will affect your financial situation,” Detweiler says. “You want to use a line of credit to grow or maintain your business, not to hurt it.”

Another source of business lines of credit is the Small Business Administration, or SBA, which partners with banks to offer the CAPLines program. Four offerings in this program help small businesses fill funding gaps.

What Are Interest Rates for Business Lines of Credit?

Interest rates for business lines of credit rely largely on personal and business credit scores.

If your credit rating is low, your interest rate may be high – at least initially. But if you use the credit line responsibly, the lender might reassess the terms.

Consider Lee’s first business line of credit with an interest rate of nearly 19.5% and a limit of about $20,000. He refinanced the line after four months of making timely payments, and the interest rate fell to about 10% and the limit increased to $35,000.

“We saved thousands of dollars with a lower rate, which for us is significant, and also increased our liquidity,” Lee says.

Most lenders depend on the five C’s of credit to determine the size of the credit line, says Christopher Ward, a small-business credit executive at Bank of America. These include:

  • Capacity, or ability to repay.
  • Character, or credit history.
  • Capital, or earnings and savings.
  • Collateral, or what you can put down to secure the line of credit.
  • Conditions, or the purpose of the loan and the strength of the economy.

Your credit limit might be a few thousand dollars up to $500,000 based on these considerations and your needs.

How Can You Use a Business Line of Credit?

You can use your business line of credit as you wish to meet short-term working capital needs. But you’ll need to be careful to use the funds strategically.

“Maybe you have a food truck, and before the Fourth of July holiday, you need a huge amount of inventory but don’t have the upfront money,” Ward says. “A line of credit would be great in this situation because you can borrow what you need right away. When you’ve made the money with that day’s sales, you pay it all back.”

A business line of credit has plenty of other smart applications, Detweiler adds. Examples include stocking up on inventory, adding staff for an important event, maintaining cash flow when customers are slow to pay or buying product at a deep discount.

Just make sure you can pay off a business credit line promptly before you get one. This will allow you to leverage the line to pay down debt as you grow your business or weather financial difficulties.

“By making payments on time, you’re also building the company’s credit rating, which can allow you to refinance your line of credit at a lower interest rate and for a larger amount,” Lee says.

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