What is a business line of credit and how does it work?

What is a small business line of credit?

A small business line of credit has more in common with a small business credit card than a small business loan.

Like a small business loan, an unsecured line of credit gives business access to money that can be used to meet any business expenses that arise. However, unlike a small business loan, there is no lump sum disbursement at account opening that requires a subsequent monthly payment.

A small business line of credit is subject to credit review and annual renewal, and is revolving, like a credit card: interest begins to accrue once you withdraw funds, and the amount you pay (except for interest) becomes available for borrowing again as you pay off your balance. As with a credit card, the lender will set a limit on the amount you can borrow.

Using a small business line of credit

The number one reason to open a business line of credit is to gain access to short-term financing. Most businesses use these funds to support the financing of operating expenses such as supplies and payroll or to increase inventory. Cyclical businesses often rely on an unsecured line of credit as a source of off-season working capital.

Unlike many small business loans, an unsecured line of credit is not designated for a specific purpose or purchase; it is a good option for small businesses looking for ways to better manage cash flow. Funds are generally drawn from the line of credit through the use of a business checking account, a small business credit card, or even a mobile banking app.

Understanding Secured and Unsecured Lines of Credit

Typically, a small business line of credit is offered as unsecured debt, which means you don’t need to put up collateral (assets that the lender can sell if you don’t repay the debt). Many unsecured lines of credit come with a variable interest rate and are available for amounts ranging from $10,000 to $100,000.

For amounts over $100,000, you may need to secure your line of credit with a general lien on your assets or a certificate of deposit.

What is required to obtain a small business line of credit?

Be sure to research the details of any lender’s business line of credit requirements. For example, many banks will require that a business has been under current ownership for a fixed period of time.

The rates on a business line of credit tend to be lower than a business credit card, which can charge more than 20% APR for purchases, and even more than that for cash advances.

Other advantages

Maintaining a credit line in good standing can help build your business’ credit rating and position you for better loan terms if you seek financing in the future. Many small business experts suggest that first-time applicants should start with a modest line of credit and pay off debt quickly as a way to build a credit profile.

Keeping your small business finances running smoothly can often be a challenge in today’s fast-paced world. Depending on your specific business needs, a small business line of credit could be the simple solution you need to meet your growth goals, at a pace that’s right for you.