If you’re in need of access to money “on demand” with low monthly payments and flexibility to invest in opportunities and run operations, you may want to consider a business line of credit (LOC).
A line of credit may help equip an entrepreneur with the flexible funds needed to stabilize and grow their business. An LOC may provide the capital you need, when you need it. A big plus for business owners is that with an LOC, you typically only pay for the money you use.
Here’s some information to consider regarding this flexible funding option.
How does a business line of credit work?
A traditional business loan is a lump sum of borrowed money, but an LOC is a revolving line you can draw against as you need it, similar to a business credit card. This means that you only pay interest for the money that you use. Typically, an LOC may be extended by a large traditional bank, a small local bank, or an online lender.
Generally, the first step is to determine how you will use the funds and how much money you need to access. With this information, you may adjust your budget accordingly.
Here’s a simple example:
- If you receive a $10,000 line of credit and use $5,000 for inventory, you only pay back the $5,000 plus interest. In the future, you may pay down the initial $5,000 borrowed and may be able to withdraw more, but only up to the $10,000 limit.
Some lines of credit have a draw period. This is a period of time when you can withdraw and pay back funds. For instance, a 12 month draw period allows you to withdraw money for a period of 12 months. The typical draw period on an LOC from a bank in the SmartBiz® network is for 12 months.
After the 12 month draw period, SmartBiz customers may reapply for an additional 12 month draw period on an LOC, a bank term loan, an SBA loan, or other financing options that our network offers.
Different types of lines of credit
When considering an LOC for your business expenses, there are generally a few options. Review your financial statements to determine which type is best for your needs.
- Traditional Secured Business Lines of Credit: The business owner puts up collateral, something of value like real estate or equipment, for this type of credit line. The lender can claim your collateral if you default, lowering their risk and resulting in lower interest rates or more flexible payment terms than an unsecured line.
For lines of credit through the SmartBiz network, a blanket UCC (Uniform Commercial Code) filing is required. This filing covers all of a company's assets—not just a single piece of collateral. In the case of borrower default, the lender can repossess and sell assets equal to the value of the outstanding loan amount. A UCC filing may help you qualify for more money than you would with an unsecured line.
- Unsecured Business Line of Credit: Collateral is not required for this type of credit line. There’s nothing to seize if you default so the lender is assuming a larger risk than with a secured line. The additional risk may make an unsecured line of credit more difficult to acquire and more expensive.
- Short-Term Lines of Credit: Short term lines of credit can be accessed quickly and are easier to qualify for than a longer-term credit line. However, you may end up paying for the speed and convenience with higher APRs. Be sure to read the fine print.
- Longer-Term Lines of Credit: This type may be less expensive but harder to qualify for than those with shorter terms. Longer term lines of credit may give you access to more cash, but the biggest benefit is there is typically a lower APR.
Tip: Look at your cash flow and income statement to determine the best fit for your immediate needs. Still not clear on the best option for your business? Check with your accountant or another financial professional to help you make the right decision.
When is it useful to open a line of credit?
Lines of credit have advantages over regular business loans. The use of funds are generally flexible, there are no set monthly payments, and no interest is charged on the unused money. When you repay a borrowed amount, those funds are typically immediately available again.
The number one reason to use a business line of credit is for short term funding needs like:
- Purchasing inventory
- Hiring a new employee Financing marketing campaigns
- Making payroll
- Unforeseen expenses
- General working capital
Another important benefit of a line of credit? It may help you build solid credit making you more attractive to lenders if you need funding in the future. Your credit report is usually the first thing considered by lenders.
Tip: If you don’t need immediate funds, it may be worth opting for a small business loan with low rates and long terms like an SBA loan.
What should you consider when opening a line of credit?
Unlike a loan, which generally is for a fixed amount for a fixed time with a prearranged repayment schedule, there is much greater flexibility with a line of credit. There are also typically fewer restrictions on the use of funds.
Tip: Consider a line of credit if you need cash fast or want to strengthen your credit profile.
Line of credit general pros and cons
- You only pay interest on the funds you use and the capital is available whenever you need it.
- While some lenders may charge fees for each withdrawal, there are never any additional fees after origination with a line of credit through SmartBiz. Draw on the money when you need it, no extra fees involved.
- The flexible structure of a business line of credit lets you use the funds in ways that make sense for your business. For example, you might hire a new staff member, acquire additional inventory, finance an upcoming project, or take advantage of a new business opportunity.
- Most businesses are eligible, even if they’re young or don’t have the highest credit scores.
- Qualifying for this type of funding is faster and easier than getting a small business loan. Typical loan applications are more involved, as banks want to avoid the risk of non-payment.
- You can immediately charge purchases or access cash.
- If you don’t have a good debt-to-income ratio and a track record of at least two years in business, you may not qualify.
- Exceeding your credit limit or paying your bill late can incur fees and penalties.
- While business lines of credit can help fund immediate, short-term needs, they may become costly over time as you withdraw more capital.
How to qualify for a business line of credit
To qualify for a line of credit from $25,000 to $150,000 from a bank in the SmartBiz network, you'll need at least two years in business and $100,000 in annual revenue.
Although some lenders don't set a minimum credit score, borrowers will most likely need a score of 660 or higher to qualify.
If the time isn’t right to apply for an SBA loan or a bank term loan, a line of credit typically offers access to fast cash and flexibility as well as the opportunity to build your credit. Each business is unique, and each situation is different.
If you’ve determined that an LOC is the right fit, learn more or apply today.