Small Business Lines of Credit: Pros and Cons

During the 2020 COVID-19 pandemic, businesses took a big hit. With operational restrictions and revenue declines, entrepreneurs are desperate for financial support.

The 2020 PPP program did provide fully forgivable loans to be used for approved expenses including payroll, utilities, rent, and more. A second draw is expected to have an easier application and a wider use of funds. But owners may be in need of fast, flexible funding now.

If you’re looking for immediate financing for your small business, we’ll help you decide if a business line of credit might be a good option for you.

Missed out on PPP? Pre-Qualify for other funding!

What is a business line of credit?

A business line of credit is a financing option that falls somewhere between a business credit card and a term loan. Virtually the only similarity a line of credit has to a small business loan is that it gives access to funds that can be used for day-to-day expenses. Otherwise, a business line of credit is more like a credit card. You don’t have a sum deposited into your account which you then repay with interest on a regular basis. Instead, you draw funds as you need them and accrue interest each time. Lines of credit are also revolving, like credit cards, which means that the amount you repay becomes available again. As with credit cards, your lender will determine a maximum up to which you can withdraw funds at any given time.

Available lines of credit

Lines of credit fall into the following four categories.

1. Business line of credit

You're more likely to be granted a business line of credit if your business has a strong payment and credit history and can demonstrate that it has the income to repay the money. This type of financing gives you access to funds for any business-related expenses.

Some lenders that extend lines of credit require a business asset, like an office building or piece of machinery, to serve as collateral for the line. Secured business lines of credit typically carry lower interest rates than unsecured lines.

2. Business credit card with a revolving line of credit

A business credit card may be the place to start if your business is new and can't yet meet the requirements for a business line of credit from a bank.

In addition to allowing you to charge purchases up to a certain limit, a business credit card gives you the option of taking a cash advance. Some cards have lower cash advance limits than the regular credit line on the card, though and these can be extremely expensive.

3. Personal line of credit

This type of financing provides access to funds for personal use. Some people open a personal line of credit to have on hand for emergencies or for a specific purpose. A personal line of credit can be secured or unsecured.

How a business line of credit works

A revolving line of credit on a business credit card "renews" continuously. As you pay down or pay off your outstanding balance, your credit line increases up to the limit set by the issuing bank.

For example, if you open a business credit card account with a $30,000 line of revolving credit and use to buy $5,000 worth of supplies for your business, $25,000 is left. If you paid the bill in full the following month, your line of available business credit on the card would once again be $30,000. If you paid it in monthly increments, your available funds for purchases or cash advances would increase by that amount until they reach $30,000.

Your bank charges interest on your unpaid balance. According to U.S. News in December 2020, the average annual percentage rate (APR) on business credit cards ranges from 14.22% to 22.18%.

If you take out a cash advance, you'll pay a higher APR plus a cash advance fee, which may be either a percentage of the funds advanced or a flat fee, whichever is more.

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Pros

  • You only pay interest on the funds you use and that the capital is available whenever you need it. You can use the proceeds for a wide variety of business purposes to help maintain your cash flow, from operating expenses to purchases to emergency funds.
  • 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, and you only pay back what you've borrowed (with interest, if applicable).
  • Depending on the issuing bank, you may receive a sign-up bonus or earn airline miles, shopping discounts, dining discounts, or other perks for using your business credit card. You may also earn cash back on purchases. Business loans don't come with these incentives.

Cons

  • 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 apply.
  • The interest rates on business credit cards are usually much higher than the interest rates on small business loans or fixed lines of credit from a bank. These rates can increase over time, and interest adds up very quickly if you don't pay your bill on time and in full each month.
  • 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 can become costly over time as you withdraw more capital.

How to qualify for a business line of credit

At a minimum, you'll need at least six months in business and $25,000 in annual revenue to qualify. Although some lenders don't set a minimum credit score, borrowers most likely will need a score of 500 or higher to qualify.

A better funding option

Need funding to rebuild your business? Don’t waste time going from bank-to-bank filling out multiple applications. SmartBiz helps you find the best financing for your unique needs whether that’s an SBA loan, Bank Term loan, or other financing.  About 90% of qualified applications we refer to banks are funded and our financial professionals are on hand to answer your questions. Discover if you’re pre-qualified here without impacting your credit scores* and read the SmartBiz 5-star customer service reviews on TrustPilot.

*We conduct a soft credit pull that will not affect your credit score. However, in processing your loan application, the lenders with whom we work will request your full credit report from one or more consumer reporting agencies, which is considered a hard credit pull and happens after your application is in the funding process and matched with a lender who is likely to fund your loan.

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