A business line of credit is the most preferred financing option for small business owners. The flexibility they offer is outstanding and incomparable. Whereas the traditional term loan will give you one lump sum of cash to use and to pay back over time – a business line of credit is more like a reserve pool of a fixed amount. With business lines of credit, you can draw capital up to the maximum limit when you need, and you will only pay interest on the amount you draw.
Furthermore, as soon as you pay back what you owe, you will have the maximum at your disposal again. In a nutshell, it’s a safety net for your business. And unlike what we generally consider as revolving credit – business credit cards – a line of credit allows your business to have access to cash and frequently at lower rates as compared to credit cards.
However business lines of credit have transformed in recent years. It is no longer the bank down the road handing them out. Here are four types of business lines of credit your small business needs to know about.
- Traditional Line of Credit
The traditional line of credit is normally meant for experienced business owners with established business models. Which makes sense since the credit maximums are substantial, the rates are lower, and the requirements demand higher credit scores and annual sales reporting. Usually, these come from the bank where you have your business bank account. In comparison to a term loan of similar size, a line of credit would possibly have a lower interest rate and closing cost – but it will likely come with a considerable interest rate hike in case you overdraw your account or fail to pay back what you have withdrawn.
In case you are a small business owner pulling out a line of credit, you will be spending that flexible cash on seasonal business expenses, payroll and different operational costs, insurance against emergencies and for surprising opportunities.
- Short-Term Line Of Credit
The difference between a short-term line of credit and a traditional line of credit is more or less similar to the difference between your usual short-term loan and traditional bank or longer-term online loan. Therefore, a short-term line of credit has a higher interest rate, lower credit maximum, quick turnaround time and flexible application requirements.
Unlike the traditional line of credit, the short-term line of credit is generally offered by means of alternative lenders versus sing banks. The point is not that one is good or bad – they attract to different business owners.
People with lower credit score, smaller annual revenues, or newer businesses might only qualify for a short-term line of credit. And although the short-term line of credit tends to be more expensive, its value lies in giving new businesses the chance to keep a flexible pool of capital.
- Line Of Credit Backed By Equipment
Beyond short-term traditional lines of credit, small business owners can also checkout lines of credit backed by certain types of collateral.
Here is the way business lines of credit work; asset-based lenders care more about your future scenarios than they do about your previous borrowing history. You get some important equipment – a vehicle, new exercising machines, a printing press – and that equipment-backed line of credit lender will give you a line of credit based totally on the value of your equipment.
The best thing is that these lines of credit tend to have more comfortable requirements even if their maximums and interest rates don’t dip – but at the cost of a lien, or claim of possession in case of loan default, on that new equipment. They are depending on the value of your inventory or equipment, instead of your borrowing history, to feel assured about your loan.
- Line Of Credit Backed By Invoices
The primary concept behind the invoice financing is that, sometimes, customers take a long time to pay you back – but you may not be able to wait for long. Rather than depending on short-term loans to cover operational expenses, or digging into your financial savings, you could get those invoices paid immediately – even though you will have accept the costs of that speed and competence.
A line of credit backed by invoices follows the same logic. The worth of your invoices determines your credit maximum, and you can draw capital as required as opposed to counting on your customers to pay on time. And as your invoices increase, you’ll usually have access to more cash from the line of credit as well. In case you are a small business owner taking into account growing your opportunities or fixing your cash flow issues, one of these lines of credit might be right for you. Whether it is only product or an additional source of capital, a business line of credit is an exceptional safety net for your small business.
How to Use a Line Of Credit
A business line of credit is a financing solution that allows a small business to draw up to a predetermined amount of cash. To get funding, you just request a draw from the line. You can pay back the line whenever you like, which increases your funds availability. Lending establishments restrict how you can use the line of credit. Obviously, considering that it is a commercial line, it can be used only for business purposes. Businesses use these facilities to cover short-term requirements which include paying suppliers, covering payroll, and managing other business costs.
The cost of using a line varies primarily based on the size of the line and the risk. The financing fee is paid at the outstanding balance. It is also variable and tied to the prime rate. Additionally, lines may also have other costs which include maintenance charges and availability charges. These expenses vary by institution. Ultimately, many banks require that your business repay the full balance of the line from time to time. This practice is something to consider if you are thinking this sort of product.
Advantages and Disadvantages of a Line Of Credit
Business lines of credit have a few different advantages, inclusive of:
- They can improve your cash flow quickly
- They can be flexible as long as you don’t reach the limit
- They can be used to pay for emergency expenses
- They are inexpensive than most funding solutions
As with any other business funding option, lines of credit have its own set of disadvantages;
- They can be difficult to acquire
- They’re not suitable for startups and businesses with less than two years of trading history
- Covenants can be difficult to meet
- As you reach the limit, it’s difficult to increase it quickly
Considering your business make the grade for a business line of credit, the decision to apply for one comes down to your main business objective. In case you cannot meet the requirements, apparently a line of credit is not an option.