Business ownership comes with many challenges, especially when you lack a large cash reserve for an emergency. Whether you have unexpected emergencies or need to cover everyday expenses, a business line of credit can help manage any short-term cash needs. What is a business line of credit, and does it differ from other types of loans? Here are a few points to consider when you need cash for your business.
What Is a Business Line of Credit?
Think of a business line as a credit line similar to a credit card. With a business line of credit, business owners often have instant access to the funds. This line of credit is usually dispersed through the business’s checking account or credit card. Like a traditional credit card, the amount will decrease as you draw on the cash. When the amount is paid off, the line of credit restores the available funds. Also, a business line of credit will have an interest rate that applies to any borrowed money.
These lines of credit are based on a review of the applicant’s credit history and score. The interest rate and limit will depend on personal and business credit. Additionally, the owner must renew the credit lines on an annual basis. Owners can use these business lines of credit to help fund any short-term expenses, such as:
- Covering payroll
- Cash flow emergencies
- Seasonal slowdown
- Building inventory
- Financing accounts receivable
Like any business account, owners should only use these credit lines to fund business-related expenses.
How Does a Business Line of Credit Work?
When a business needs short-term funding, a line of credit may be a good option. As seen with the recent pandemic, unexpected challenges can happen. In some instances, a business may need more cash to pay utilities, rent, or payroll. When the business’s cash flow returns to normal, the owner can repay all the borrowed money with interest.
The interest rates can be fixed or variable. A fixed interest rate will stay the same over the life of the loan, but those variable rates can fluctuate depending on the overall rates in the country. Before applying for a business line of credit, it is crucial to know the type of interest rate. A fluctuating interest rate could be detrimental to the financial health of a business.
Generally, lenders will allow a business owner to repay the borrowed amount without fees. In that case, the business can avoid paying additional interest on the loan. There is often a grace period where no interest will accrue on the borrowed amount. Before applying for a line of credit, business owners must look at the payment schedules. Typically, lenders will require weekly or monthly payments to satisfy the loan amount.
Additionally, many of these lines of credit do charge fees. They can include:
- Application or origination fees
- Withdrawal fees
- Late fees
- Inactivity fees
- Account maintenance fees
With these lines of credit, owners can draw on the funds as long as there is credit in the account. Like any loan, interest rates and other fees could add to the total amount owed on the credit line. In some situations, business owners can find themselves in financial trouble when relying on these lines of credit for their primary business funding.
What Is the Difference Between an Unsecured and a Secured Line of Credit?
A business line of credit may be secured or unsecured. With a secured line, the lender will require some collateral from the business, usually in the form of property or inventory. If the company cannot repay the line of credit, the lender can seize those assets.
On the other hand, an unsecured line of credit will not require any collateral. While assets are not used to secure the loan, a personal guarantee must be made, holding the owner liable for the borrowed amount. A lender can also put a lien on business assets if the owner fails to repay the loan.
With all that in mind, business owners must carefully examine the lender’s terms. Not repaying on a line of credit could affect the individual’s personal and company credit for years to come, even leading to a seizure of assets.
Getting a Business Line of Credit
Business owners who apply for a line of credit will notice the process is similar to that of a credit card or loan. There are a few steps to follow. First, the owner needs to know how much funding is required. Many business lines of credit range from $2,000 to $250,000. While it could be tempting to overborrow on these lines, the business will be liable for unpaid funds. In many situations, the lender allows a borrower to request an increase in the line of credit.
The eligibility for the loan will depend on a couple of factors, such as personal credit score and monthly business revenue. Most lenders will have a minimum credit score of at least 680, but some will still offer a limited line of credit for those with lower scores. Along with that, lenders want to see a specific minimum monthly revenue. Without that, securing a business line of credit could be challenging.
Business owners will need documentation for the line of credit during the application process. These pieces of information can include articles of incorporation, personal and business bank statements, business licenses, profit and loss statements, and other financial statements. The type of documentation required will vary depending on your lender.
Business owners must correctly fill out these applications. Any error in the business documentation, loan amount, or personal contact information could delay approval. An application should be up-to-date and accurate. Otherwise, it could lead to a denial from the lender.
Should You Apply for a Business Line of Credit?
A business line of credit can help in the short term, but is it a wise financial decision? That answer will depend on the business’s creditworthiness and need for funding. Business owners must approach any credit with some caution. Interest and fees can quickly accumulate, leaving the owners liable for additional business debt. Also, borrowing beyond the company’s repayment means could be tempting.
However, business lines of credit can help bridge any gaps in cash flow. A line of credit provides security and peace of mind for eligible business owners. You must approach any credit with caution to ensure the financial health of your business. Once you understand the basics of a business line of credit and how it works, you can decide whether it is the right choice for your company.
Find Funding from a Leading Lending Company
At New Bridge Merchant Capital, our reputable funding and exceptional customer service have made us a trusted leader in the business finance industry. If you need help selecting the right loan or line of credit for your business, contact us.
