What are Business Lines of Credit and How Exactly do They Work?

Posted at February 4, 2020 » By : » Categories : Business Funding »
business lines of credit

What if your business could grow at the rate of your ambition? Chances are you have big plans for the future of your business. However, the hard part of future plans is finding the money to make it happen.

Business lines of credit provide one of the best ways to fund various needs. But many business owners and managers don’t know how these lines work and what they can do for a business.

Curious about lines of credit for your own business? Our comprehensive guide has all of the information you need!

What are Business Lines of Credit?

We’ve prepared a thorough guide to what these lines of credit are and how they can help your business. First, though, we must define what a business line of credit really is.

The short answer is that a line of credit functions like a credit card. Your business will be approved for a certain amount of funds. At that point, you can borrow up to the full amount of that line whenever you need it.

Payments also function as they do with a credit card. You will accrue interest on the amount you owe from month to month. Once you pay off the line of credit, you will owe nothing outside of any annual fees.

Who Offers Business Lines of Credit?

Let’s say you’re interested in taking out a line of credit. Who can you get this type of funding from? Almost every major bank and credit union offers this type of financing.

As a rule of thumb, they will offer a credit line if they also offer business loans. It’s typically easier to open a business line at a bank where you have a personal account. But with so many lenders available, you can also afford to “shop around” and find the most competitive interest rates.

How do Business Lines of Credit Work?

Earlier, we covered that these credit lines work similarly to credit cards. However, there are a few more things you should know about how they work.

Once the line of credit is open, you can use it for almost any business-related expenses. It can go towards anything from unexpected seasonal expenses to covering payroll for your employees.

It’s important to know that the bank sees credit lines as very different from loans. Therefore, some lenders may expect you to pay off your credit line for a short period within the year. This helps prove that you are not borrowing more money than you can realistically pay off in the short term.

Speaking of short terms, it’s important to understand the ideal use for these funds.

Short-Term Versus Long-Term

When it comes to business funding, we’ve covered the two main choices: a business loan or a business line of credit. When is it best to take out the latter?

Generally speaking, credit lines are designed for short-term funding needs. Stretching any credit debt over a long period of time means that you are paying more and more in interest. Paying it off quickly means you get the money you need right away without letting interest pile up.

Most businesses eventually get a line of credit for short-term needs and then take out loans for longer-term needs. In some cases, the line of credit can help a young business to qualify for a larger loan.

Building for the Future

Business lines of credit are very versatile and can be used for just about anything. But when a business takes out a loan, they typically have a specific need in mind. That often results in loans that are usually larger than the typical line of credit.

Generally speaking, it is harder to qualify for a business loan than a line of credit. And if you get them from the same lender, getting a line of credit first can help you qualify for the loan. This is because a lender evaluates more than just your credit score.

They also scrutinize whether you will be able to pay the loan off or if your business is a bad investment. If you have a year or more of managing a business credit line, the lender will see you as a dependable client. This can help move the needle towards approving your loan when the time comes.

Business Lines of Credit Qualification Requirements

How, then, do you qualify for a line of credit? The exact requirements vary from lender to lender. Generally speaking, you must have an established business.

Lenders don’t typically provide loans to help you start a new business, and they are very skeptical of a young business. However, an established business that wants to set up a modest line of credit is likely to be approved.

As with personal lines of credit, you can always request that the lender raise your credit limit after you have proven to be reliable. Finally, the amount of credit you require may dictate whether collateral is required or not.

Do You Need Collateral?

Just like business loans, there are secured and unsecured lines of credit available. Secured lines of credit require some form of collateral whereas unsecured lines of credit do not. Collateral functions as a kind of security for the bank.

If you are unable to pay what you owe, they can claim your collateral to help cover your losses. With credit lines, typical forms of collateral include accounts receivable, inventory, or commercial real estate.

The lender may require a certificate of deposit as well as file a lien on your assets. Collateral can help you get a bigger line of credit, but it’s important to never get more than your business needs.

What are the Advantages?

There are many ways for your business to get funding. So, why should you choose business lines of credit instead of a traditional business loan or even a credit card? Generally speaking, lines of credit have better interest rates than credit cards.

You can usually get approved and get access to money quicker with a credit line than a loan. Once you have a line of credit open, the money is available whenever you want to use it.

When it comes to money, it’s better to have it and not need it, than need it and not have it!

What Comes Next?

Now you know business lines of credit can help you and your company with its cash flow. But do you know where you can apply for a line of credit today?

We specialize in all kinds of business loans and business lines of credit to help your company grow. To see how we can help make your ambition into reality, come apply today!