How a Business Line of Credit Works

how a business line of credit works

When your need money to meet your business’s working capital or strategic investment needs, a business loan is probably the first option you consider. After all, it is one of the most widely used types of available business funding. More than $850 billion worth of business loans are borrowed each year in the United States.

However, another form of funding might not be on your radar that can come in quite handy when you are in a cash crunch. It is a business line of credit, also referred to as a revolving line of credit, and it is the choice of millions of business owners nationwide. This Balboa Capital blog article explains how a business line of credit works and how it can benefit your small business.

Access to credit, whenever you need it.

To understand how a business line of credit works, it is essential to know how it differs from a traditional business loan. For starters, a loan is a one-time lump sum of cash that is repaid, along with interest, over a specific time. On the other hand, a business credit line is not a sum of money you borrow.

It is a specific amount of capital that you can access and repay with interest whenever you need it. When determining your credit line amount, lenders look at several factors, including your small business credit rating, time in business, and debt-to-income ratio.

Simple repayments.

A business line of credit can help you better manage your cash flow because you only need to repay when you draw from the line. For example, if you have a $150,000 credit line and draw $30,000, you will only need to pay back the $30,000, plus interest. You will not have to pay interest on the $120,000 balance that you carry.

Most lenders offer daily, weekly, and monthly repayment options. However, it is worth noting that you might be responsible for a monthly maintenance fee, so make sure you take the time to read the fine print. Additionally, check to make sure you can make payments early without being subjected to a penalty.

Secured vs. unsecured line of credit.

You have two types of credit lines to choose from, secured and unsecured. Secured lines of credit present less risk to lenders and, as a result, have lower interest rates typically. However, you will need to put up collateral such as inventory, equipment, or vehicles to qualify. These assets can be repossessed if you do not adhere to your repayment schedule.

Unsecured lines of credit do not require collateral, but they have higher interest rates. That is because the lender is assuming a higher risk. When deciding between a secured and an unsecured credit line for your business, look at your individual needs and budget. For example, if you need access to funding immediately and do not mind paying extra, an unsecured credit line might be a good option.

Common uses of credit lines.

Credit lines can help you meet your short-term business needs quickly. For example, you can use it to start a new work-related project, purchase inventory and supplies, pay bills, and keep your small business afloat if you experience a dip in sales. In short, you can use your credit line for just about any daily business need you have.

Summary.

As you can see, a credit line can be a real lifesaver for your business if you are short on time and cash or if you have been unable to obtain a different form of short-term financing. Lastly, a line of credit presents your business with a win-win scenario.

Not only does it give you instant access to a fixed amount of capital, but it also helps build your business credit rating. Each time you draw from your line and pay it back on time, you are giving your credit score a little boost that can help you get better rates in the future.

The information in this blog post has been prepared for informational purposes only. It is not intended to provide and should not be relied on for tax, legal, investment, or accounting advice. You should consult with your accountant, lawyer, or tax advisor before making any business decisions or moving forward with business funding.