. Small business owners can access capital via a business line of credit to help them expand, purchase equipment, purchase inventory, hire or retain talent, acquire another business, and more. There are many things to consider before opening a business line of credit such as qualification requirements, choosing the right lender, interest rates, and more. In this article, we will explore why a business should consider opening a line of credit.
What is a Line of Credit Loan?
A small business line of credit is similar to a credit card. Lenders will establish a credit limit for the maximum amount of money they will lend to a borrower. The borrower can then tap as much as they need up to the limit. Like a credit card, the borrower will only pay interest on the amount that is borrowed.
In most cases, having a business line of credit is very beneficial because running a business isn’t always smooth sailing. Entrepreneurs know that surprises are around every corner and having access to capital can help navigate those periods of uncertainty. This type of financing is very popular among small business owners.
Preventing unanticipated expenses is impossible but having a business line of credit is a great way to be prepared for them. There are also opportunities around every corner and having access to capital can help you take advantage of them. Sometimes the window of opportunity is very slim and a business line of credit can give you the immediate cash you need to act.
Should a Small Business Apply for a Line of Credit Loan or a Business Credit Card?
There are similarities between a business line of credit and a business credit card but they are two very different ways to access capital. In general, interest rates for credit cards can be much higher than a line of credit loan. Receiving cash with your credit card means paying a fee and/or a higher interest rate for a cash advance. Credit cards have inflexible monthly payments that require you to meet the payment in full or be charged a high-interest rate. With a line of credit loan, you may be able to arrange custom repayment terms that fit your business cycle.
Traditional lenders (like traditional banks and credit unions) offer both lines of credit and credit cards to established businesses and startups alike. However, online lenders, typically only offer a line of credit loan and not business credit cards. So you have more options when looking to open a business line of credit than you do a business credit card.
What is the Difference Between a Loan and a Line of Credit?
A loan is a cash infusion where a small business receives a lump sum of an agreed-upon dollar amount from a lender. A business line of credit is similar to a credit card; the lender will establish a credit limit for the maximum amount of money they will lend you and you can tap as much as you need up to your limit. Like a credit card, you pay interest only on the amount you borrow.
There are many types of loans to choose from and many different reasons why a small business would want to open a loan over a line of credit depending on the situation.
Benefits and Disadvantages of a Line of Credit Loan
A business line of credit is a versatile and flexible financing option for businesses that allows them to take advantage of immediate-term, short-term, and long-term opportunities or downturns as they present themselves. Let’s review the pros and cons of a line of credit loan.
Benefits of a line of credit loan are:
Competitive Interest Rates: For small businesses that have an established credit profile and meet a certain annual revenue threshold, a line of credit loan can come with competitive interest rates that are comparable to those of a business loan. This is a benefit because it is typically easier to open a business line of credit than it is a loan.
Flexible: A business line of credit can be used for any business expense. Unlike small business loans, which have specific rules around what the money can be used for, you are free to use capital from a business line of credit in any way you choose. This is a major reason why a small business should open a business line of credit. It is impossible to predict the future, and whether a setback or opportunity presents itself, having access to cash can be very beneficial.
Revolving: A business line of credit can be revolving. This means the business line of credit is open-ended and can be used and paid down repeatedly as long as the account remains open. Keep in mind that some credit lines can have a specific draw period.
Ready cash: Once a business line of credit is open, you can draw cash from it very quickly. There are no additional applications or screenings after you open a business line of credit. Having cash at the ready can provide small business owners with the working capital they need to operate.
No collateral needed: Businesses with a strong credit profile can typically open an unsecured line of credit loan. Meaning the line of credit can be opened without any collateral or personal guarantee.
An unsecured loan is preferable to a secured loan because your personal assets or the assets of the business are not at risk.
Disadvantages of a Business Line of Credit:
Collateral/collateral needed: In cases where a business does not have a strong credit profile, the lender might require collateral to open the business line of credit with real estate, inventory, or cash savings. This is referred to as a secured business line of credit.
If you are a newer business that must provide collateral, consider opening a business line of credit for the smallest amount possible. From there you can use the money and paying it back on time to build your credit profile. The next time around, you will likely be able to open a line of credit for a larger dollar amount without any collateral.
Higher rates for low credit score: Like the above con, a business without a strong credit profile will likely be offered a business line of credit with higher interest rates. In this case, it might be beneficial to consider a variable interest rate.
Fees: Some lenders charge a draw fee. This is a fee you incur every time you draw cash from your line of credit, and they vary based on the lender. Typically, a draw fee is between 1% and 2% of the amount withdrawn at the time.
Some lenders might also charge an annual fee for the privilege of keeping your business line of credit open.
Less money than a loan: If your business needs a lot of money – hundreds of thousands or even millions of dollars – a business line of credit might not work. A business loan is typically a better choice for very large sums of money.
Conclusion
Securing a line of credit loan is a decision that all small businesses must take carefully. It is recommended that you go over the terms and conditions carefully before applying for the loan.