Understanding business lines of credit is important for all business owners

Understanding business lines of credit is important for all business owners

 There are more than 30 million small businesses in America, according to the US Small Business Administration.1 However, managing cash flow is a common concern for business owners, which is why many organizations apply for a line of credit to support them in financing new projects, conducting daily operations, and more.

Business lines of credit are widely available, but they may occasionally be confusing to understand, so it's important for potential borrowers to understand how they work before employing one. You should be aware of the following.

What is a line of credit for businesses?

The ability to borrow a specific amount of money when you need it applies to both personal and company lines of credit. You can use your line of credit to cover the cost of the repair if, for example, a car in your delivery service breaks down. Seasonal business owners might need to obtain a line of credit to pay for goods in July that they will sell in December.

Lenders often only charge interest on the amount you actually use, so even if your line of credit is $50,000, if you borrow $10,000, you'll only be required to pay interest on that amount. Revolving lines of credit are also known as lines of credit, and as long as you make your payments on time, you can use one repeatedly.

However, there is a significant distinction between personal and commercial lines of credit. Since businesses normally require more capital to function than homes do, business lines of credit typically have significantly higher borrowing limits, which can range from $5,000 to $150,000.

How to make a business line of credit application

Banks and other conventional lenders typically request to see your income history, tax records, bank account details, a balance sheet, and a profit-and-loss statement when you apply for a business line of credit. In general, your business will also need to generate at least $25,000 in annual revenue and be operational for six months. Typically, you also need a credit score of at least 500 because lenders want to be sure you can repay them.

Watch out for fees.

Many people think that lines of credit come with an interest rate and that's it. Unfortunately, there are often additional fees that can increase the total loan cost. For example, some banks charge origination fees, which are costs to set up a loan. Depending on the type of loan, there can also be administration fees, pre-payment fees, annual fees, and more.


Then there's the interest rate, which some banks determine based on your credit score. If you have an excellent credit score, lenders are more likely to consider you a trustworthy borrower and will feel more comfortable loaning you money at a lower rate. If you have a lower score, prepare to pay more – rates can range from a few percent to about 20% or more, depending on the lender.

Rates are also determined by the Federal Reserve's Fed Funds rate. When it rises, as it has over the last three years, borrowing costs climb too.

Secured versus unsecured.

While lines of credit or working capital-related loans are essential to helping business owners manage their day-to-day cash flow needs, there are other types of loans too.

A popular option for companies is the traditional, fixed-term business loan, which allows people to borrow much more than they can with a line of credit. It works in a similar way to a mortgage – you borrow a lump sum and then pay it back over time. This is ideal for capital-intensive projects where you need a large cash infusion to get something off the ground.

Loans can also be secured or unsecured. A secured loan is when you put up collateral, such as a piece of equipment or a building, that a lender can then take possession of if you don't pay back the loan. Secured loans typically come with lower interest rates because it's less risky for the lender. If something goes awry, they can seize that asset to recoup any losses.

With unsecured, you don't have to put any assets up for collateral, but an institution may charge a higher rate for the additional risk.

How fast can you access the funds?

Once a lender approves you for a line of credit, you can usually start using it right away. But use the money wisely – it's easy to get deep into debt, to the point where it becomes difficult to pay the outstanding amount back. If you're only covering the minimum monthly payment, then the interest you owe will only keep growing.

Was a business line of credit the right move?

Usually, companies will have an idea as to what they want to use a line of credit for, but for many businesses, it just sits there until they need it. But if your business is thriving because of it, and you're able to pay it off in a reasonable time, then applying for one was the right decision. 

As long as there are businesses operating in America, there will be lines of credit to help them manage their expenses and cash flow. It's a key tool in the entrepreneur's toolbox and one that can be a big factor in fueling business growth.

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