If you’re a business owner, a business line of credit is a great way to access short-term funds for business expenses. Especially if you have fluctuating demand, seasonal expenses or customers paying via installments.
In this guide, we’ll go over the ins and outs of a business line of credit and give you the necessary steps to apply for one.
What Is a Business Line of Credit and How Does It Work?
A business line of credit is a type of loan that functions more like a credit card (aka revolving credit). Borrowers receive a line of credit from a lender with a set credit limit. You can use your line of credit for any business-related purchase or investment up to your credit limit. Much like a credit card, the credit you use becomes unavailable until you pay it back.
Unlike credit cards, a line of credit has a lender draw period, which is the time limit for withdrawing money.
Draw periods usually range from 1 – 5 years and vary by lender. Each month during the draw period, you are only required to pay the interest on what you’ve borrowed. You don’t have to pay down your balance yet – unless you want to. However, if you borrow your entire credit limit, you will have to pay toward your balance in order to borrow again.
When the draw period ends, the loan enters repayment and your window to withdraw funds closes. At this point, you continue making your monthly payments – which are now made up of the accrued interest and the loan’s principal balance – until the loan is paid off. This repayment period may have an expiration date at which the line of credit will be closed.
Unsecured vs. Secured business line of credit
An unsecured line of credit is a loan that doesn’t require collateral. That said, a lender may still require you to sign a personal guarantee or a blanket lien. This ensures the signer continues to make payments on the debt (even if the business can’t), or grants access to collateral, should the business default. Since lenders assume more risk with unsecured lines of credit than secured ones, interest rates are usually higher.
Conversely, a secured line of credit requires collateral, which provides the lender with protection if you default on the loan. Collateral is something of value the lender can take possession of and sell to recoup losses from a default. The type of collateral will depend on the lender’s requirements but can be anything from equipment or inventory to bank accounts.
Most of the time, business lines of credit are offered as unsecured debt. But if you take out a higher line of credit, a lender may require it to be secured.
Business line of credit vs. Business loan
While a business line of credit is a type of loan, it’s not to be confused with a business loan. With a business loan, you receive the money in a lump sum and repay it (plus interest) over a fixed schedule. Once you receive the money, interest begins to accrue and the total amount of interest you pay is based on the full amount of the loan.
With a business line of credit, you have access to funds when you need them, and you only pay interest on what you withdraw, not the entire credit line.
However, interest rates on loans are usually lower than those on a line of credit. This can make budgeting with loans easier, especially if you’re a small business.
Benefits of a Business Line of Credit
A business line of credit is great for businesses that need access to working capital but don’t need it all upfront.
Here are some more benefits of a business line of credit:
- Flexibility: A line of credit offers more flexibility than a loan. You can access the funds when you need them and continue borrowing as long as you pay down what you use and continue making monthly payments.
- Quick turnaround: You may be able to get a line of credit faster than a business loan. Sometimes in as little as one day.
- Only pay interest on purchases: You only pay interest on the money you withdraw, so there is less pressure on you to spend the entire amount than there is with a business loan.
- Build credit: Taking out a line of credit can help you build business credit when you manage it responsibly and make your payments on time, which can help future you secure a better loan.
If you’re working on a lengthy project with variable expenses, it may make more sense to get a line of credit than a business loan. Or if you’re working on a project that requires access to larger funds, it may make more sense to get a line of credit than a business credit card.
What To Consider Before Applying
Getting a business line of credit makes sense when your business has a healthy cash flow but needs short-term financing. However, taking on more debt may not be a good idea if you’re struggling financially.
So before you apply for a business line of credit, there are a couple of things you’ll want to consider.
Interest rates on a business line of credit can be fixed or variable depending on the lender and type of loan. Interest rates on a line of credit are usually higher than those on business loans but can be lower than a business credit card.
Higher business credit scores increase the likelihood of favorable interest rates.
Credit lines can come with many fees and they can vary between lenders. So make sure you read the loan terms. Here’s a list of some of the fees you may encounter:
- Draw fee: Charged when you withdraw from your line of credit (usually based on how much you withdraw)
- Late fee: Charged when you make a late payment
- Maintenance fee: Charged either monthly or annually (keeps your line of credit active)
- Inactivity fee: Charged if you don’t use your line of credit for a set length of time
- Payment processing fee: Charged to process transactions on your line of credit (different from a draw fee, and you may encounter both)
- Termination fee: Charged if you close your line of credit before the expiration date
- Prepayment fee: Charged if you repay your withdrawn amount ahead of schedule
Taking these considerations into account before you apply for a line of credit can help you make the best decision for your business as you start the application process.
Explore and Compare Your Lender Options
Before you begin exploring your options, estimate how much money you need to borrow so you can look for lines of credit that match or exceed your needs. Just remember to use your credit responsibly if you apply for a higher credit limit than you currently need! If you end up needing more than your initial credit limit in the future, you may be able to ask your lender for a line of credit increase.
Once you have an estimate of how much you need, you can start looking for lenders that offer that credit limit, such as banks, credit unions and online lenders.
However, due to lender requirements, it may be more difficult for a newer business to get a business line of credit (more on requirements later). Online lenders may be more willing to work with riskier or newer borrowers, which could mean less favorable loan terms.
Shopping around will help you compare annual percentage rates (APRs), repayment terms and draw periods. Knowing the requirements will help you determine which lines of credit you may qualify for.
Confirm Your Eligibility
Check the line of credit you want to apply for to make sure you meet the specific requirements, as they will vary by lender and loan type. The three main requirements lenders consider for a business line of credit are time in business, revenue and credit history. This means that small businesses need not fear because the size of the business doesn’t usually matter.
Time in business
Some lenders have a minimum requirement for how long your business has been operating. Most require you to be in business for at least 6 months or a year, but it can be longer. The longer you’ve been in business, the more stable your business looks to lenders and the more likely they may be to approve your application.
Lenders may have a minimum revenue requirement. You may find that online lenders have less strict requirements than traditional banks or credit unions. Some lenders will have small business line of credit options for those with lower revenue.
Your qualification is heavily dependent on your credit history. If your business is new or has a thin credit history, a lender may consider both your business and personal credit reports. So you’ll want to check your personal credit score as well. Lenders will typically look for a credit score around the high 600s, but some lenders will work with businesses and individuals that have bad credit.
Prepare and Submit Your Application
The information required for each business line of credit application will vary by lender. If you want to speed up the application process, contact prospective lenders to learn about their specific requirements.
Here are some of the things you’ll need during the application process:
- Legal business name, address, phone number and tax identification number (aka EIN)
- Personal income, Social Security number and date of birth
- Type of business structure (corporation, nonprofit, sole proprietorship, etc.) and business industry
- Years in business and number of employees
- Financial and tax statements (both business and personal), profit and loss statements and annual revenue
- Estimated monthly business expenses
Check your application thoroughly before submitting, as errors can cause a delay in receiving your funds. When you’re ready, submit your application. Now the wait begins! You could receive an approval notice right away, or it could take several days. This will vary by lender. The lender may also ask you to submit additional documents before they decide to approve your application.
Once approved, the lender will send you a loan agreement to sign before issuing you the line of credit.
You’re in Business Now
A business line of credit is a great option to fund larger, short-term expenses you might not be able to fund with a business credit card. It’s also more flexible than a business loan.
The application process and qualifications vary by lender, so make sure you read the requirements carefully as you follow the steps we’ve outlined.
The Short Version
- The three main requirements lenders consider for a business line of credit are time in business, revenue and credit history
- Due to lender requirements, it may be more difficult for a newer business to get a business line of credit
- The information required for each business line of credit application will vary by lender