What do you do when your biggest account has an emergency and can’t pay their invoice due to you for three months in a row? While you may sympathize with your client, you need to be paid. A business line of credit loan can cover events like these, because let’s face it, your business has expenses, including rent and payroll too.
In the course of nearly any business operation, an urgent need for cash will arise. You know you can trust your client to come through...eventually...but right now, you need a plan. That’s why for many businesses, it makes sense to have a line of credit in place so when you need cash, you can access it.
How does a business line of credit work?
The idea behind a business line of credit is that it works a lot like a credit card. You can draw on the line of credit, up to a limit, when you need it, and pay back the funds with interest over time. However, unlike a credit card, the amount you can draw on is typically much higher -- in some cases as much as $250,000.
There are two kinds of business lines of credit: secured and unsecured. The differences between the two are just like they sound. And unsecured line of credit comes without a collateral, or security in the form of assets, requirement. A secured line of credit requires collateral. An example of a secure loan is your car loan. If you stop paying your car loan, the bank has the ability to repossess the car and recoup their money. In business, you would offer an asset like real estate or inventory against a line of credit that you can access for cash.
How is a line of credit different from a loan?
A line of credit and a loan have a few key differences.
The first is that a business loan comes with a fixed amount of money disbursed to your business along with a term for repayment. You accept all the money at once, and start accruing interest immediately.
With a line of credit, you’ll have access to funds, but you’ll only pay interest when you actually take money from the credit line. And when you pay back any principal you’ve borrowed plus interest, your obligation ends until you need to access cash again.
Lastly, standard loans often require some form of collateral. An unsecured business line of credit doesn’t require collateral.
Benefits of a business line of credit loan
There are benefits to having a business line of credit in place. First, and perhaps most importantly, it gives small business quick access to cash when it’s needed. You won’t have to go through the process of applying for a loan, then facing the possibility of getting turned down when you business needs an influx of cash.
On a related note, once a line of credit is in place, you’ll be able to seamlessly transfer cash from the line to your bank account, meaning that it can take seconds to have the money depending on how your business accounts are set up.
Business lines of credit also offer the option to pay more or less towards your debt each month, unlike a traditional loan which requires a fixed monthly payment. Like a credit card, there will be a minimum monthly payment, but as long as your payment covers that amount, you have some flexibility.
Lastly, having a business line of credit and making regular payments on it can help establish and grow your business’ credit score, demonstrating to future potential lenders that your business is a good financial risk.
How do I get a line of credit for my business?
Securing a business line of credit can be more challenging than other kinds of financing. Because they are flexible, and make it easy to access cash, and tend to come with a high credit limit with a relatively low interest rate, lenders want borrowers to have a good credit score and a solid business history.
Your credit score will determine part of your eligibility for this kind of loan -- the better the score, the higher your credit limit at a lower interest rate your line of credit terms will be. Having a business history of at least a year, along with solid financial information about your business will also help build a case to lenders that your business is a good risk.
When you’re ready to apply for a business line of credit, you’ll gather your financial paperwork, compare a few interest rates and credit limits to find a good fit for your business, and apply.
Can you use a business line of credit for personal expenses?
Business owners can sometimes make the mistake of accessing cash from their business line of credit and using it for personal expenses. For example, if you need a down payment for a large expense like a home, it might seem to make sense to borrow money from your business -- after all, it’s your business -- to make the payment.
However, the IRS has very strict rules about how businesses pay taxes versus how individuals pay taxes, and combining the two can cause problems, including hefty penalties, for your business and personal finances.
Another issue to watch out for is that like credit cards, with a business line of credit, it can be very easy to slip into debt that starts to get harder and harder to pay. And with large credit amounts like a business line of credit offers, it can be even more risky.
What is a good rate for a business line of credit?
Typically, banks advertise rates as low at 5% for a business line of credit, which is much lower than most credit card interest rates and is one of the benefits of establishing a line of credit.
However, when you actually go to apply for a loan, you’ll likely find that the rate you’ll be asked to pay is a bit higher, and sometimes a lot higher, as much as 20% depending on your credit score, business history, and funding needs.
You’ll want to shop around and compare rates for your loan so you can ensure the best deal for your business. Keep in mind, you might be able to secure a better rate and credit line if all of your financing is fulfilled at one bank and set up as a total financial package.
You might also find that you can get a better rate and a larger credit line limit if you choose a secured loan instead of an unsecured one.
How to find the best line of credit loan for your business
Finding the best line of credit for your business is like taking out any other kind of loan. You’ll need to gather your financial information and paperwork and apply for the credit, then weigh the pros and cons of each offer you might receive.
Make sure to take into account any fees or additional charges that come with each loan, for example, origination fees or monthly charges that could potentially accrue when your line of credit isn’t “active,” or you haven’t borrowed from it a few months.
How to apply for a business line of credit
You’ll need to take a few steps to apply for a business line of credit, though everyone’s process will be a bit different. Knowing your options is the first step in securing the line of credit.
Then, you’ll gather your paperwork and business financial information for the bank to review. Next, you’ll probably want to make appointments at a few physical banks to see what terms they can offer you, before checking out the options online lenders can provide.
Lastly, you’ll fill out a few applications and choose the offer with the best terms for your business. Soon, you’ll be well on your way to accessing the cash your business needs, when you need it.