What is a Business Line of Credit?
A business line of credit (LOC) is a pool of funds that the borrower can withdraw on demand. For example, a business could have a line of credit up to $150,000. When these funds are needed for everyday business expenses, the company could withdraw from this line of credit. If it withdraws $50,000 and pays this figure back along with the interest, then it can still withdraw up to $150,000. Interest is only charged on the amount that is withdrawn. Business lines of credit can be constantly drawn from once the initial amount borrowed along with the interest has been paid back.
How a Business Line of Credit Works
A business line of credit is different from a term loan, where a lump sum is paid upfront to be repaid over time at fixed intervals. With a line of credit, as long as you do not withdraw beyond your credit limit and make payments on time, you can use it over and over. Lines of credit are typically smaller than term loans, ranging from $5000 to $150,000. Usually, for smaller credit amounts less than $50,000, collateral is not required.
A business line of credit works similarly to a credit card, where you repay the overdrawn amount along with the interest. After this has been completed, the borrower is free to use the credit card/line of credit again to the maximum limit. The difference between a line of credit and a regular business credit card is that businesses will have a higher line of credit and actual cash is provided directly into the bank account. Additionally, credit cards have higher fees as well as annual fees and late payment fees. Lines of credit can also provide rewards much like a credit card.
Who Can Use A Business Line of Credit?
Business lines of credit are better suited to established businesses with larger recurring expenses. Most business lines of credit are used for everyday operations such as payroll, supplies, general cash flow, seasonal inventory, or any other item that can pop up while running a business. Even if cash flow is optimal right now, every business gets stuck from time to time. Successful maintenance of any company requires a regular cash flow. For this reason, many companies apply for a line of credit and only use it in rare instances, when they actually need it. It is a very flexible form of finance, and they are often the first choice for companies before term loans.
You will usually need to be in business for a year with annual revenue of $25,000 minimum to be considered. Additionally, applicants may need a credit score of 600 or above. Lines of credit usually need to be repaid within 3-12 months and are a form of short-term finance as opposed to long-term. APR rates can range from 9%-99% depending on credit history and annual business turnover, among other variables.
While the rates can be high, this is offset by the fact that businesses only need to use what they need, when they need it. And they only pay interest on what they borrow. A business line of credit is highly sought after and difficult to acquire for many.
Pros and Cons of Lines of Credit
- Can withdraw an unlimited amount of funds once repaid.
- No collateral is required for smaller amounts.
- Only need to withdraw what is needed
- Can be difficult to get a line of credit. Usually, only large established businesses can get them.
- If you miss a payment the rates are quite expensive.