Line of Credit Explained
Business loans have long provided business owners with the capital they need to invest in their business and allow it to grow to its full potential. There’s a wide variety of business loan types that are specifically designed for different purposes and which may also cater to specific financial profiles, such as startups as opposed to long-standing businesses.
A business line of credit is a type of business loan that’s popular due to its flexibility. It’s a revolving line that business owners can draw against as needed and is most commonly used for short-term funding that can pay off unexpected expenses and improve cash flow.
How is a Line of Credit Different from a Business Loan?
While a business line of credit generally falls under the umbrella of business loans, it’s actually pretty different from your traditional business loan for a variety of reasons. Let’s start with the similarities.
A line of credit loan is often considered a business loan simply because it’s money lent to a business owner that can be used for virtually any business-related expense. It can be used to replenish inventory, make payroll, and cover other business investments. It’s just a lot more flexible.
Here’s how a line of credit loan differs from your traditional business loan:
- They’re used multiple times.
- Payments aren’t monthly like normal business loans, but instead the amount owed is paid off only when used.
- A creditline (just like a credit card) doesn’t have any closing costs.
- A credit loan is used primarily for short-term purposes.
- They typically have lower interest rates than business loans.
Recommended Lines of Credit
How to Apply for a Line of Credit
While applying for a line of credit is typically less involved and more lenient than applying for your traditional business loan, there are still a few steps involved and things to consider, such as qualifications and the application process.
When it comes to qualifying for a business creditline, banks and online lenders look at several factors—the level of importance for each can vary depending on the lender, though revenue and time in business generally hold more weight than credit score.
Monthly or annual revenue
This is a determining factor when going through the application process with a lender. Some lenders will require your business to have a minimum monthly or annual revenue as a way to evaluate performance.
Time in business
How long your business has been operating is another metric lenders will look at. Some will have a minimum time of business when applying for a business creditline of 6-12 months, but not all will have a minimum. Some lenders offer a business credit line to startups.
Credit score
Many lenders will look at a business owner’s credit score to determine how risky it is to lend to them. Typically, those with higher credit scores (680 and above) have better chances of not only getting approved, but securing the best business line of credit rates.
Once you have a better idea of the qualifications involved in securing a line of credit loan, the next step is to start applying and comparing lenders to see what the best credit line rates are. If your business is new, you’ll want to be on the lookout for lenders who cater to startups, since time in business is often a requirement, as mentioned above.
Understanding what lenders look at will help prepare you when it comes time to searching for the best lender.
Choosing the Right Line of Credit Provider
Just like with any loan (personal, business, or otherwise), a business credit line comes with costs. While there aren’t any closing costs, you can expect to pay interest rates and possibly annual fees or late fees.
One of the key components to look at when comparing lenders is APR range. If you’re submitting a quick preliminary application using an online marketplace like Lendio, you can easily see the APR from various lenders you qualify for.
If you’re applying directly with a specific lender, check their website to see what their APR range is. Keep in mind that many online lenders will only conduct a soft credit check that won’t harm your score. So it may be worth it to submit an application to get a more accurate APR estimate.
Some other considerations when choosing the right provider:
- Time of funding
- Credit score minimum
- Monthly/annual revenue minimum
- Creditline amount offered
- Time in business minimum
What to Avoid with a Line of Credit
While a business line of credit can be a great way for a business to gain access to quick and flexible capital, it’s not always the right solution.
A business line of credit has a few downsides which should ultimately be considered when deciding if it’s the right financial tool for you:
- It often comes with fees and additional charges for maintenance and withdrawals.
- Business lines of credit typically have smaller borrowing limits and are intended for short-term use. This wouldn’t really be a good option for businesses who need a larger long-term loan.
- It can be difficult to acquire a line of credit loan for newer businesses.
- There is also higher risk involved. A business line of credit must be repaid even if a company fails.
Final Word
A business line of credit can be a powerful financial tool. It’s flexible and provides fast cash when your business needs it. It can even help your small business build good credit, which will come in handy down the road if you ever need to apply for a larger business loan.
Now that you have a better understanding of what’s involved and what you have to gain, the next step is to get started in comparing lenders to find the best provider for your business.
*The required FICO score may be higher based on your relationship with American Express, credit history, and other factors.
**All businesses are unique and are subject to approval and review.
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