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Starting and growing a business requires working capital. There are many ways that you can invest in your business. According to the Federal Reserve, lines of credit are one of the most popular financing options for U.S. businesses. Forty-three percent of all financing applications were for lines of credit, followed by business loans, and SBA loan or lines of credit. Let’s take a look at one of them: a business line of credit.
What is a business line of credit?
A business line of credit is flexible, revolving capital that gives you access to cash. The way it works is that a bank or online lender may approve your established business for a certain dollar amount, or limit. Then, when you withdraw funds, you subtract that number from the total credit limit to determine your remaining available credit. And once you withdraw funds, interest starts to accrue.
For example, if you have $10,000 in credit and spend $2,000, you have $8,000 in available credit. A business line of credit is revolving credit, so when you pay back that $2,000, you once again have access to $10,000.
A business line of credit can be used again and again (as long as you’re within your credit limit and in good standing). And it doesn’t have to be used on just one thing, so you can get it before you actually anticipate needing it. You might use it for inventory at one point and then for an unforeseen repair the next.
How is a line of credit different from a term loan?
A term loan is a type of business loan that is repaid on a regular schedule with a fixed or floating interest rate. A loan gives you all the money at once, in a lump sum. This means that if you need additional capital, you would have to apply for a new loan or refinancing.
Depending on the loan provider, you may need to have a specific purpose, with a stated goal and projected benefits, to apply for a loan (although this isn’t always the case). Term loans are often used for larger investments, like equipment or technology for your company.
If you’re interested in applying for a term loan, you’ll want to do your own research on lending institutions. Among the things you should pay attention to are the total payback and the ease of repayment.
How is a line of credit different from a credit card?
Both a credit card and a line of credit are revolving forms of credit, but there are also a few differences. The money from a line of credit is sent to your bank account, so you can then use it to write checks, pay invoices, or run payroll for your business. Lines of credit are also typically used for larger purchases than you might use for a credit card and come with a maximum credit limit, so you control how much you spend and the cadence with which you spend it. Credit cards typically come with a physical card; you can make purchases up to a credit limit, and you need to make minimum monthly payments.
How can I use a business line of credit?
There are a number of ways you might use a business line of credit. Some of that depends on how large your line is. But you also want to take into consideration how quickly you can pay off your line of credit.
Because business lines of credit can be procured before you know what you might need the funds for, they can come in handy when you have unforeseen expenses or need to manage your cash flow.
For example, if you run a salon and the pipes burst unexpectedly, you could use cash from a line of credit in the short term to get it fixed quickly (so you don’t lose out on too much business).
Or, let’s say, you run a restaurant that also caters to large events. If your invoices aren’t being paid quickly enough, but you need to buy inventory for your next job, a line of credit could fill that gap until invoices are paid.
Whenever you decide to seek funding for your business — whether it’s a business line of credit, a small business loan, a small business line of credit, or another form of financing — be sure to do your research, thoroughly review your books, and consult with your legal or financial advisors.
What types of business lines of credit are there?
If you’re looking into a business line of credit, be aware that there are two kinds: secured and unsecured lines of credit. Secured lines of credit are backed by your assets. These assets (for example, equipment) serve as collateral, and lending institutions may take recourse in case of default. A small business line of credit, specifically, is typically offered as an unsecured debt, which means you do not put up collateral.
How to get a business line of credit
The process to obtain a secured line of credit may take longer than the process for an unsecured line because your assets may need to be verified and appraised as a source of repayment. Whether or not your line of credit is secured or unsecured may also affect the amount of money that you have access to and the interest rate that you are charged.
If you’re interested in how to get a business line of credit, you’ll need to talk to your lending institution to determine what a secured or unsecured line would look like for your business and what materials you will need to provide for the application. The requirements and repayment terms can differ among lending institutions and online lenders.
Where to get a business line of credit
There are many options when it comes to acquiring a business line of credit. Here are just a few:
- Traditional banks: You can inquire in person or look on a bank’s site to see what the terms and interest rates are for a business line of credit they might offer.
- Credit unions: A credit union is similar to a bank but is owned and operated by its members and operates like a cooperative. A credit union is a nonprofit financial institution, and any profits are distributed among its members. Often, members will be a part of a shared community, such as sharing an employer. Among other offerings, like savings accounts or accepting deposits, credit unions also offer business lines of credit.
- Online lenders: Online lenders typically refer to non-bank lenders. They may not accept deposits, have in-person locations, and have more restrictive offerings to customers. However, among those restricted offerings, they can typically offer loans, lines of credit, or credit cards.
- Small Business Administration (SBA): The SBA is an independent agency of the U.S. government that provides resources and support to small businesses. They can provide business owners with investment capital, grants, bonds, disaster assistance, and loans. The SBA offers several different lines of credit options through its CAPLines program.
In addition to the options above, there are alternative lenders that can provide business owners with lines of credit, such as fintech companies.
Is there interest on a business line of credit?
A business line of credit typically comes with interest. However, you will only pay interest if you draw from it. Those ranges can vary depending on the lender. As the borrower, you are responsible for paying interest on the money you borrow. According to a recent Bankrate article, the typical line of credit ranges from 8–60% or higher, depending on your creditworthiness. Factors like the length of time you’ve been in business, your credit scores, and other business-related financials all contribute to your overall creditworthiness. The better your credit, the more likely you are to be offered a favorable interest rate and lower fees.