What Is a Business Line of Credit?

Many small businesses face challenges when managing cash flow. With so much money constantly moving in and out, what happens when it slows down or an unexpected expense arises?

That’s where a business line of credit can help.

A business line of credit is a flexible, revolving loan from a bank or other financial institution. It gives business owners access to a specific amount of money to use whenever you need it.

Ready to dive in? Here’s how a business line of credit works, along with its key benefits and potential risks.

How Does a Business Line of Credit Work?

Obtaining and using a business line of credit is a fairly straightforward process.

First, you’ll need to apply for one through a bank or other lender. Well-known options include Bluevine, OnDeck, PNC, Wells Fargo and Capital One—but many others exist, so be sure to research and compare to find the best fit for your business.

Like with loans and credit cards, a potential lender will need to evaluate your creditworthiness and business history.

Once approved, you’ll be set a credit limit based on your business’s financial health and size. Then, you’ll be able to withdraw funds as needed, typically via bank transfer or linked credit card.

Interest will begin to accrue once you start using your line of credit, and you’ll need to repay to avoid snowballing interest and fees.

Like a credit card, you cannot exceed the credit limit until you repay what you’ve spent. As soon as you make a payment, those funds will be available to you once again.

What Are Secured Versus Unsecured Lines of Credit?

When researching lines of credit, you will likely come across the terms “secured” and “unsecured.” It’s important to know the difference so you can make the right choice for your business. 

Secured Lines of Credit

Secured lines of credit are backed by collateral. By putting an asset held by your company on the line, you’ll generally be able to obtain lower interest rates and higher borrowing limits.

Secured lines of credit are typically more accessible to borrowers with lower credit scores. They’re also a good choice if you’re purchasing a high-value, long-term asset, such as commercial real estate or equipment.

However, secured lines of credit may have restrictions on how you can use your funding. 

As well, it’s important to always repay a secured line of credit. Defaulting can mean having your collateral liquidated or seized, which could have serious consequences for your business.

Unsecured Lines of Credit

Unsecured lines of credit are not backed by collateral, making them riskier for the lender. As such, they generally have stricter requirements, lower available credit limits and higher interest rates.

However, you are typically able to be approved for credit faster, and there are fewer restrictions as to what you are able to do with the money. They’re a good choice if you need a flexible financing solution. 

Plus, if your company doesn’t have any significant assets, an unsecured line of credit might be your only option.

Comparing Secured and Unsecured Lines of Credit

The chart below summarizes the key differences between secured and unsecured lines of credit to help you compare:

What Is the Difference Between a Line of Credit and a Business Credit Card?

A business line of credit and a credit card work similarly. 

Both options lend you revolving credit and require you to pay it back by a certain time, charging you interest and fees on unpaid debts. 

Additionally, both allow you to spend credit on whatever you want, as long as you don’t surpass your borrowing limit.

But there are a few important differences.

Business credit cards are typically used to cover smaller purchases and expenses. You are able to make transactions directly in-person or online, just like a personal credit card.

Lines of credit, on the other hand, provide you access to funds that you can transfer to your business account for larger expenses like payroll or vendor payments. 

Moreover, lines of credit often have higher credit limits than cards, although this varies depending on the lender, your financial history and whether the line of credit is secured. This makes them ideal for larger expenses and purchases.

Many small businesses use both credit cards and lines of credit to cover expenses and fund growth opportunities. It’s worth taking the time to understand how you can use both options to help your business grow smarter.

What Are the Benefits of a Business Line of Credit?

Flexible Usage

It can be tough to secure a business loan if you don’t know exactly how much funding your business needs. A line of credit gives you more flexibility, and with on-demand funding, you’ll be able to respond to business expenses on an as-needed basis.

Potential Savings on Interest

Interest rates on lines of credit are often lower than those offered on traditional credit cards, especially if you opt for a secured line of credit. Lower interest rates can help you save thousands of dollars long-term.

No Prepayment Penalties

Many traditional loans have restrictions on how you must repay the lender, with some penalizing you for paying off your debts early. In most cases, lines of credit do not have prepayment penalties, although this may vary from lender to lender.

Emergency Funding Source

Every business has unexpected emergencies or seasonal fluctuations. Even if you don’t need a large line of credit to draw from right now, it can be a good idea for your business to have on hand for those unplanned moments.

What Are the Risks of a Business Line of Credit?

Potential of Overborrowing

Business lines of credit make it easy to borrow money, but that can come with huge risk. Never borrow more than you can repay, and always manage your debt responsibly.

Requires Active Management

Like personal credit cards, revolving lines of credit require you to actively manage all withdrawals and repayments. Poor choices and excessive spending habits can hurt your business, damage your credit score and prevent you from securing more funding later on.

Fees and Penalties

Always read the terms and conditions of a potential line of credit. Some lenders charge extra fees or slap you with penalties for making late payments or exceeding your credit limit. No business wants to waste money, so knowing how to use your line of credit to avoid unwanted fees is crucial.

Final Thoughts

A line of credit can be an essential tool in the arsenal of any growing business. It offers you the flexibility to manage your day-to-day expenses, handle unexpected costs and take chances on opportunities that come your way.

However, as with any financial decision, it’s important to do your research and manage your funding properly to avoid accumulating debt.

If you’re wondering whether a business line of credit is right for you or how to obtain one, ask the experts. Finvisor’s financial advisors help you move your business forward, guiding your growing business toward success. 

Reach out to us today and set up a free introductory call.