What Is a Business Line of Credit?
A business line of credit (LOC) is a type of financing that provides a borrower with a revolving credit limit. A revolving line of credit works similarly to a credit card in that a company has access to a certain amount of funds and it only pays interest on the amount it borrows. Then, when the funds are repaid, the amount gets replenished and the business can withdraw from the line of credit again.
A line of credit is an excellent loan option for businesses looking for flexibility and access to cash when they need it. This is why most small business owners choose to open credit lines even if they don’t need them at the moment. It provides quick access to short-term working capital for business expenses, such as:
- Purchasing materials and supplies
- Repairing and maintaining business equipment
- Covering day-to-day expenses during slow seasons
- Investing in expansion opportunities
What Can You Use a Small Business Line of Credit For?
Most companies open a business line of credit to have easy access to short-term working capital. Business owners might use the credit to cover operational expenses like buying inventory or paying wages and salaries. For instance, seasonal businesses often use their lines of credit to stay afloat during low sales seasons.
The great thing about a line of credit is its flexibility. You’re free to use it for any business purpose, whether it’s to manage your cash flow or to expand your operations. With Clarify Capital, you can receive up to $750,000 in a business line of credit. Use it to buy a piece of equipment to help you manufacture more products or hire new employees if that’s what your business needs to expand.
If you’re a small business owner or a new business owner, this type of financing also provides an opportunity for you to build your credit profile. It also gives you access to funds that you can use in case of unexpected expenses. You can even use it to cover gaps in your cash flow when customers don’t pay on time. It’s a win-win-win.
Who Should Consider a Small Business Line of Credit?
Every business owner should consider getting a line of credit. It’s something you should have, even if it’s just to give you peace of mind that you have access to cash whenever your business needs it. When you know you don’t have to worry about cash flow, making decisions in managing and expanding your business becomes easier.
Since it’s a revolving credit where you only pay what you take out, you can continually access funds as you pay them back. This flexibility allows you to keep making growth-driven decisions knowing you have the capital to support them.
How Does a Small Business Line of Credit Work?
When you open a business line of credit, your business receives access to a fixed, predetermined credit limit. You can keep withdrawing and repaying your line of credit as often as you need. Just make sure you make the payments on time and don’t exceed your credit limit.
Some smaller LOC accounts can be used like a credit card, as well. For example, you can withdraw cash through a credit card tied to the line of credit or write checks from the account. Some lenders also offer the option of transferring funds from the line of credit to your business bank account.
The advantage of this type of loan is that you only pay interest for any cash you withdraw, and interest rates can be fixed or variable. Variable interest rates typically follow any change in the economy.
Every month, you’ll receive a statement displaying any changes in your account, such as payments made, any interest charges, and the available balance. Since every lender has its own conditions, you can expect different payment schedules. For example, a weekly, monthly, or periodic payment schedule is typical for business lines of credit. Some repayment periods may also depend on the amount borrowed.
Some lines of credit, especially those offered by traditional banks, may provide a grace period where you can draw funds and make interest-only payments. After the grace period, you’ll enter a repayment period to start paying down the balance.
Similar to credit cards, additional charges like annual fees, draw fees, and prepayment fees are not unusual for some LOCs. In addition, there might be monthly maintenance fees if you don’t use the line of credit. Before you consider opening a credit line account, make sure you understand all the terms and conditions.
At Clarify Capital, we believe that success begins with being prepared financially. This is why we offer solutions to help you keep your operations running smoothly. Speak to a dedicated advisor today and see how a business line of credit can help you manage occasional cash flow shortages.
Common Types of Business Lines of Credit
There are several types of business lines of credit to consider when looking for business financing. They include:
Secured business line of credit
This type of LOC requires owners to pledge assets as collateral to secure the debt. If the business can’t pay the line of credit, the lender will take ownership of the collateral as payment. Lenders may ask for personal or business property. Some lenders may even match the collateral to the type of debt. For example, since a line of credit is a short-term liability, it might be secured with short-term assets, such as accounts receivable or inventory. As a result, lenders don’t often require capital assets, like real estate or equipment, to secure a LOC. Collateral lowers the risk for the lender, so a borrower may get a lower interest rate.
Unsecured business line of credit
This type of LOC doesn’t require assets as collateral but most lenders will ask for a personal guarantee and a general lien. In addition, your business must be profitable, and you may need a strong credit history to qualify for an unsecured line of credit. However, unsecured lines of credit are generally offered in smaller loan amounts with slightly higher interest rates. If you’re a company operating for many years and have an excellent business credit rating, though, you may qualify for unsecured credit lines at reasonable rates.
Real estate line of credit
This type of LOC is a secured loan with real estate as collateral. It is beneficial to small business owners willing to offer property as collateral in exchange for better repayment terms and interest rates. The asset could be a commercial property, a farm, or personal property like a home. Some lenders also accept built-up equity in a real estate asset as collateral similar to a home equity line of credit (HELOC). The lender will have a claim to that portion of the asset’s equity if the business defaults on its loan.
Business credit cards
A business credit card also works like a line of credit. However, it’s best used for smaller ongoing expenses, as it may cost the business more to withdraw cash from a credit card. It can be a good starting point for new businesses without established finances to qualify for other types of financing.
The Difference Between a Line of Credit and a Credit Card
As mentioned, a line of credit works similarly to a business credit card. However, there are several key differences, such as:
- Business lines of credit tend to have much lower interest rates than credit cards.
- Some lenders also offer longer payment terms for lines of credit other than the monthly payment schedule of a credit card.
- A line of credit provides a higher credit limit because it can be secured by collateral.
- A borrower can withdraw cash from a line of credit, while credit cards charge additional fees for balance transfers and cash advances.
- A line of credit is best used for larger expenses, while a credit card works best for smaller ongoing expenses.
- A business credit card may provide rewards or cash back, and small business owners can take advantage of 0% interest promotional offers.
The Difference Between a Line of Credit and a Term Loan
A line of credit and a term loan are both considered short-term liabilities (i.e., current liabilities that need to be paid within one year). However, one can be a better option than the other, depending on your business goals. Take a look at some of their key differences:
- With short-term loans, you receive a lump sum amount at a fixed interest rate within a defined repayment period.
- With a line of credit, you get access to a revolving credit that you can use, repay, and withdraw from again repeatedly.
- A short-term loan requires you to make equal monthly payments over a specific term until the loan is paid off.
- With a line of credit, you only pay interest for the amount you borrow.
- Lines of credit are best used for unexpected business expenses, while a term loan is ideal for one-time projects, like buying equipment or machinery.
What You Need to Get a Business Line of Credit
All types of businesses can apply for a line of credit. Interest rates and loan amounts vary from lender to lender. Whether you apply through a bank, an online lender, or a credit union, here are key things you need to prepare.
Proof of Time in Business
Loan providers use your time in business to assess your creditworthiness. They also use it to measure their risk in lending to you. Lenders tend to see longevity as stable and less risky.
So, the longer your business has been in operation, the lower the risk for lending companies. To qualify for a line of credit, most lenders require that you be in business for at least six months.
Records of Annual Revenue
When you’re applying for a line of credit or any type of business loan, lenders also require that you show records of your company’s cash flow and income. They want to know that you have the capacity to pay back the amount borrowed. A strong revenue shows you can handle your obligations.
Also, your cash flow statement helps lenders calculate the maximum amount you can borrow. Most lenders require businesses to have at least $10,000 per month in revenue to qualify for a line of credit.
A credit score represents your payment history, the amount of debt you have, and the length of your credit history. And although there are lines of credit for both good and bad credit scores, a higher score helps you get better interest rates and repayment terms.
Higher credit ratings mean you have shown responsible credit behavior in the past, making lenders feel confident in giving you credit in the present. Most lenders want to see a personal credit score of at least 550 for you to qualify for a line of credit.
As a business owner, make sure to track your credit scores from the three major credit reporting agencies: Equifax, Experian, and TransUnion. Creditors, such as banks, credit companies, phone companies, etc., report to the credit bureaus, which use scoring criteria and models to calculate your score.
Businesses have credit scores, as well. The rating typically ranges from 1 to 100. You can check your score with Experian, Equifax, and Dun & Bradstreet. If your score is low, taking out small business loans or starting a line of credit and using them responsibly can help you improve your business credit rating.
How to Get a Business Line of Credit
Most lenders require businesses to have a strong revenue, a good credit score, and be operational for at least six months to qualify for loans. Now that you know the minimum requirements, you can start preparing if you’re planning to apply for a business line of credit.
Check your credit score and get the following documents ready:
- Legal proofs, such as a driver’s license, passport, federal tax ID, or employer identification number (EIN)
- A copy of your business license
- 3 to 12 months of recent bank statements
- 1 to 2 years of business tax returns
- 1 to 2 years of personal tax returns
- Financial statements, such as profit and loss (P&L) statements and balance sheets
If you need a larger amount of credit, you might be asked for collateral so prepare the documents for that, as well. Know that each type of lender has different requirements, interest rates, payment terms, and application processes, though.
For instance, banks may have stricter requirements, and they also take longer to process applications. Similarly, loans administered and guaranteed by the U.S. Small Business Administration (SBA) have strict rules and conditions, as well. On the other hand, online lenders tend to have more relaxed criteria and faster credit approval times.
Can You Get a Business Line of Credit With a Poor Personal Credit Score?
Whether you’re applying for a personal loan or a business loan, lenders look at your credit score and credit history. Of course, this isn’t an unreasonable expectation because lenders want to know you can pay back your loans. But we know that having poor credit isn’t always because someone has mismanaged their finances.
It can be due to circumstances beyond a person’s control, like illnesses or other emergency situations. So, if you have poor credit and you’d like to apply for a business line of credit, your best option is to ask for help from professionals like Clarify Capital.
Contact us and speak to a Clarify adviser. Tell us your story so we can help you craft a strong loan application. We also work with more than 75 lenders, and you only need to convince one to fund you.
Grow Your Business Today With a Business Line of Credit Through Clarify Capital
As you grow your business, you’ll find that one of the biggest challenges might be managing your cash flow. Even good events, such as a big order from a customer, may send you scrambling for additional capital to make sure you can deliver.
As a business owner, you need to be prepared. Thankfully, there are financing options available that you can use to manage cash flow gaps.
At Clarify Capital, we understand that running a business is complicated enough. That’s why we strive to keep things simple, convenient, and transparent. We work with more than 75 lenders to get you the best rate. Apply online or speak to us directly by calling (877) 838-3919 and get the funding you need in as little as 24 hours!