A common unwritten business rule is that it’s better to have access to financing before you need it. If you wait until your business is in a desperate financial situation to apply for a loan, you may not get the funding you need in time. That’s why taking out a line of credit could be a smart move for some businesses. [Read Related: Small Business Financing Options That Bypass Traditional Banks]’
A line of credit gives you access to the financing you need before you need it, but you only have to repay the amount you actually spend. It serves as something of an insurance policy in the event of any unexpected financial challenges or growth opportunities that require additional capital. However, before jumping at this type of financing, it is important to understand the pros and cons so you can decide whether this financing option is right for you.
A business line of credit gives you access to a predetermined amount of money that you can borrow from on an as-needed basis. Instead of receiving an upfront lump sum, you have access to a revolving line of credit.
It’s similar to a credit card, but a business line of credit tends to come with much higher credit limits. As with a credit card, you can use it to make cash withdrawals or transfer funds to your business checking account.
Editor’s note: Looking for a loan for your business? Fill out the below questionnaire to have our vendor partners contact you about your needs.
A business line of credit is ideal for short-term operating expenses, like payroll or inventory. You can take out as much money as you need, assuming it doesn’t surpass your credit limit. Then, you can either pay off the remaining balance or make minimum monthly payments.
The nice thing about a business line of credit is that you’ll only pay interest on the money you spend. For instance, if you have a $50,000 line of credit but only use $10,000, you’ll only pay interest on the $10,000.
A business line of credit provides business owners with access to a revolving line of capital when they need it. The borrower only pays interest on the amount spent, and when they repay the money, they can access the line of credit again.
A business line of credit and short-term loans are similar in that both give you access to working capital for your business. These two financial products just go about it in different ways.
With a short-term loan, you’ll receive a one-time lump sum of money. When you qualify for the loan, you agree to repay the principal with interest over a set period. Business loans follow a fixed repayment schedule, and you’ll know how much you must pay every month.
Business loans are a good option to fund a large, planned expense. For instance, if you’re looking to invest in a marketing campaign or purchase new equipment, a term loan may be a good choice.
A line of credit, meanwhile, allows you to access a certain amount, but you don’t receive the funds all at once. You draw from your line of credit on an ongoing basis, and there are no set repayment terms.
A business line of credit is ideal for companies that are looking for flexible financing options. You have ongoing working capital needs and want to have the cash flow available to cover business expenses as they arise. For more information read our best options for startup funding.
For many businesses, cash flow varies monthly, and there may be discrepancies between the amount coming in and the amount going out. And expenses often come up that are hard to plan for.
A business line of credit gives you access to the funding you need, typically with lower interest rates than what you’d pay for a credit card. It can help you cover a variety of expenses, such as these:
The line of credit you receive will either be a secured or unsecured loan. A secured line of credit requires some type of collateral. For instance, you could use property or equipment to secure the line of credit. Banks and credit unions commonly give out secured lines of credit. This collateral gives the bank more security because, if you default on the line of credit, it can collect on the collateral.
An unsecured line of credit doesn’t require any collateral. This is ideal for most business owners, because you’re not putting your business or personal assets at risk. [Related Content: How to Get a Traditional Bank Loan]
Like most financing options, business lines of credit have both benefits and drawbacks. Knowing both will help you understand if this is a good option for your business.
If you’re looking for a flexible financing solution to manage ongoing cash flow needs, applying for a business line of credit could be the right move. However, the application process can be demanding, requiring you to share a lot of personal and business information.
Compare all your options during the application process. Using a lending marketplace is a good idea because it allows you to submit one application and receive quotes from multiple lenders.
[Check out all of our reviews of the best business lenders.]
Some of the requirements will depend on the business loan you choose, but here are a few of the things you need to qualify for a business line of credit: