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Updated: April 30th, 2021
If you’re looking for flexible short-term funding for your business, a business line of credit could be exactly what you need, as it gives you access to a specific amount of money that you can dip into on an ongoing basis.
As a business owner, there’s no shortage of the unpredictable scenarios that may come your way: a new pizza oven suddenly malfunctioning, a (way) overdue accounts receivable that’s squeezing your cash flow, or your seasonal business failing to meet revenue expectations due to the previous summer’s less-than-stellar weather.
A business line of credit can take the pressure off any cash flow issues that come your way and keep your operations running smoothly. In this guide, we’ll dig into the following:
A business line of credit allows you to access capital, ranging from $5,000 to $500,000 or more, if and when you need it. With a business line of credit, you don’t make payments or rack up interest until you actually use your funds.
Credit lines work best for short-term financial needs. This includes ongoing operating costs, smaller purchases, or any situation that might result in a temporary shortage in cash flow.
A line of credit gives you increased financial flexibility and is best used as a tool to help fill gaps in working capital.
So, how does it work in practice?
Let’s say you’re approved for a $50,000 business line of credit with a 14% interest rate. You decide to draw $10,000 to invest in top-notch inventory management software that’ll help maximize sales for the upcoming holiday season.
With a repayment term of 12 monthly payments, you would have to pay back $11,400 ($10,000 plus $1,400 in interest) in total.
You would still have access to the remaining $40,000, and once you paid back the $10,000 you used (plus interest), your credit limit would return to the original $50,000 you were approved for.
This is why most lines of credit are classified, similar to credit cards, as “revolving.” You can usually tap into these funds again and again—assuming you’ve paid back what you borrowed.
However, it’s important to keep in mind that terms vary across lenders. For example, in some cases, you may need to reapply for financing each time you draw from your line of credit.
Like any other business financing option, there are several pros and cons to lines of credit.
While at first glance $50 or even $100 bucks may not seem too bad, these numbers can add up quickly. That’s why—as with any other form of business financing—it’s so important to have a plan and use your business line of credit strategically.
When choosing the right line of credit for your business, there are some important differentiations you should understand.
Revolving vs. non-revolving: While most lines of credit are revolving it’s important to understand there is a non-revolving line of credit. What does that mean? Let’s use the example from earlier where you were approved for $50,000. This time around, after you used the $10,000, you’ve decided to use the additional $40,000 to keep things afloat during the off-season. With a non-revolving line of credit, once you paid back the $10,000 and $40,000 in full (plus interest), rather than having access to the full $50,000 again, your account would be closed.
Secured vs. unsecured lines of credit: With secured lines of credit, you’re required to put up some type of collateral or guarantee, which the lender can seize if you default on your payments. Collateral can include (but is not limited to) real estate, equipment, or inventory. On the other hand, unsecured business lines don’t require the borrower to put up any type of collateral. However, because the lender is accepting more risk, you can likely count on higher interest rates.
While lenders typically have varying eligibility requirements, to qualify for a business line of credit, you will likely need:
Not all lenders ask for the same information. Online lenders may ask you to fill out a short questionnaire and link your business bank account so they can quickly assess the financial status of your operation, or they may request a variety of documents to evaluate your application. The benefit of using a service like Funding Circle is that it allows you to compare your options from a variety of lenders in one place.
While different lenders may require different documents, you can never be over-prepared when applying for a business line of credit. Use this as an opportunity to get your paperwork in order. Some of the most common items requested include:
A credit card is technically a line of credit, so these two forms of financing can be confusing. They’re both tools that can finance aspects of your business while helping you to build your business and personal credit, which can result in more favorable terms for future loan products.
So, what’s the difference between a credit card and a business line of credit?
Access to cash. With a credit card, you purchase products and services with credit, and then pay your bill later — ideally, in full by the due date listed in your billing statement. With a line of credit, you have access to cash that is deposited into your checking account (once you draw from your credit line).
While credit cards are convenient and made for retail purchases that require a quick swipe, there are a multitude of other scenarios where you may need to write a check or access a large amount of cash in a short period. Some credit cards allow cash advances, but it will cost you significantly more than a line of credit, and you’ll like only be able to borrow a fraction of your credit limit.
Rewards: Unlike lines of credit, business credit cards tend to offer cash back or travel rewards. Plus, some business credit cards come with an introductory 0% APR period.
Credit limits: Lines of credit typically have higher borrowing limits than credit cards.
Note: A line of credit is structured so you pay back what you borrow (plus interest) over the course of six to 12 months. This can help when it comes to budgeting payments over time. On the other hand, if you don’t pay off your business credit card in full each month, you may find yourself racking up debt due to overwhelmingly high APRs.
There are several key differences between a line of credit and term loan.
Repayment: You don’t make payments or accrue interest until you actually draw from your business line of credit. So if you borrow $50,000, but only use $20,000, you would only pay interest on the $20,000. With a term loan, on the other hand, you’re given the lump sum of $50,000 upfront which you start paying right away — even if you realize you only need $20,000 to get the job done.
Loan terms: Lines of credit are generally capped at 12 months. With a term loan, typical repayment periods range from 6 months to 5 years.
Use case: A line of credit offers flexibility and is ideal for keeping your cash flow in a good place. If you own a seasonal business, a business line of credit could help you cover payroll during the slow season or purchase inventory to gear up for the busy season. However, depending on a line of credit to cover specific long term business investments just isn’t sustainable. A good rule of thumb is to use a term loan for bigger and more specific needs.
Funding Circle and our network of partner lenders are here to help you find the financing that’s right for you. Business lines of credit are incredibly flexible as you can draw out funds when you need to, and only pay interest for the money you borrow. As you repay what you have drawn, your line of credit will replenish and can be tapped again.
If you need business capital, consider taking a few minutes to apply for a business line of credit with Funding Circle today.
Louis DeNicola is the president of LD Money Media LLC and an experienced finance writer who specializes in credit, personal finance, and small business finance. Within the small business sphere, he helps business owners understand their financing options, cash flow management, business credit, and taxes. In addition to Funding Circle, you can find his work on BlueVine, Credit Karma, Experian, Wirecutter, and Lending Tree.