What is a line of credit?
A business line of credit can provide organizations with funds up to a preset borrowing limit.
Find out about the advantages of the solution, as well as the differences between secured and unsecured lines of credit.
If you are looking to unlock funds for your business, then a line of credit (LOC) could be a useful borrowing solution. A business line of credit provides funds up to a preset borrowing limit, making it a more flexible alternative to loans and credit cards.
You can draw capital when required and will only pay interest on the amount spent. The available credit replenishes as your spending is repaid, meaning you can access ‘revolving credit’ to meet your company’s cash flow needs.
How a Line of Credit Works
There are a number of comparisons between a line of credit and a credit card. They both allow the account holder to access funds up to a maximum limit. You can also access the funds as required.
Interest only accrues on the amount you borrowed, not the full credit limit. The full limit restores once the account holder repays the amount owed. This creates ‘revolving credit’ to meet the changing financial needs of your business.
A business line of credit will generally offer access to funds between $10,000 and more than $1 million, with repayment terms typically spanning between six months and five years.
The Advantages of a Line of Credit
While LOCs do have similarities to credit cards, they also offer several advantages over more traditional borrowing options. The first distinction is that LOCs will typically have lower APRs than credit cards, making them a less costly form of financing.
It is also much easier and more affordable to take out cash advances with a line of credit than with a credit card.
The LOC issuer will typically provide the account holder with a checkbook and credit card for purchases, payments, or cash withdrawals. In contrast, cash advances from credit cards have high interest rates and will usually incur expensive fees.
Unlike a term loan, LOCs allow you to draw funds when necessary. And unlike credit cards, you won’t usually be required to make monthly payments.
However, it is worth noting that the lifespan of a line of credit is shorter than that of a credit card. LOCs tend only to be open for a period of a few years, while credit cards can be maintained indefinitely. Business credit cards also offer rewards and benefits to account holders, which are not matched by LOCs.
How a Business Line of Credit Could Help
The most effective way to use a business line of credit is to meet short-term cash flow needs. That might include paying employees, purchasing inventory or new equipment, and providing relief during emergencies or slump seasons.
Taking out a line of credit with a provider that reports to the major credit agencies can also improve your business credit score. Making small purchases with a LOC and meeting the repayments on time can help to boost a company’s creditworthiness. A higher credit score makes it more likely that lenders will accept a company’s credit applications and offer them more competitive rates. It also shows vendors, suppliers and other business partners that the company is likely to reliably meet repayments.
As they tend to have higher interest rates than term loans, LOCs are usually not ideal for funding larger purchases. Franchise investments, department expansions, or office renovations probably aren’t something you want to fund with a LOC.
The Difference Between Secured and Unsecured Lines of Credit
A credit provider may offer a secured or unsecured line of credit. The major difference between these types of LOCs is whether or not any collateral is required.
Secured Lines of Credit
A secured line of credit requires the account holder to provide a valuable asset as collateral for the credit they receive. The collateral will need to match or exceed the value of the LOC’s maximum limit and can come in the form of the company, its property, or equipment.
Secured LOCs tend to offer higher credit limits and more competitive interest rates, as providing collateral mitigates the risk that the lender takes by extending the line of credit.
If a business defaults on payments and the lender seizes assets to recoup its losses, a secured loan allows the borrower to designate assets for possession.
Unsecured Lines of Credit
An unsecured line of credit does not require the borrower to provide any form of collateral. These are best suited to businesses seeking smaller credit limits up to around $100,000, as they tend to have lower maximum limits and higher interest rates.
Lenders can still seize personal assets for outstanding payments on unsecured business LOCs if the company is unable to provide the funds.
Qualifying For a Business Line of Credit
Lenders base interest rates, repayment terms, and maximum credit limits on several factors, including the business’ credit score, financial history, and revenue.
To qualify for a business line of credit, a company owner will typically need to provide evidence that they have at least $50,000 or more in annual revenue, one year in business, and a personal credit score of 550 or above.
However, businesses with a lower credit score or less credit history may still be able to qualify for a short-term line of credit. These short-term options can also be a useful tool in improving a business’ creditworthiness, making it easier for them to secure medium or long-term LOCs in the future.