If you’re wondering if a business line of credit makes sense for you, this article will help you understand the benefits and drawbacks of this type of financing and help you make an informed choice. If a loan sounds like the better choice, check out our best business loans to find your right fit.
Key Insights
- Offering flexible funding and fairly low rates, business credit lines can be a great financing option.
- Lenders may offer secured or unsecured business credit lines.
- You may need to have at least two years in business to qualify.
Understanding the Basics of Business Lines of Credit
A business line of credit works similarly to a credit card. You receive a total credit limit from a lender and can spend against it, pay it down, and spend against it again.
How to apply for a business line of credit
Banks, credit unions, and online lenders may offer business credit lines, and you may need to provide different documentation as part of the application process, depending on the lender you choose. Generally, though, lenders request the following:
- Business line of credit application
- Business tax returns for the last two years
- Business plans
- Personal tax returns for the last two years
- Financial statements, including your balance sheet, profit and loss, A/R AP aging report, and debt schedule
- Personal financial statements
- Proof of collateral (if secured)
- Personal guarantee
- Personal credit check
You’ll likely need good credit, a healthy balance sheet, and at least two years in business to qualify. Once you’ve applied, your lender will evaluate your application and documents and determine your eligibility for a credit line.
If approved, your total credit line and interest rate will vary depending on your business’s age, income, credit, and overall financial health. For instance, established businesses with strong financials could qualify for larger credit lines and lower rates—while newer, less financially sound businesses may end up with smaller credit limits and higher interest rates.
Secured vs. Unsecured Business Credit Line
Another important thing to note before applying is that business credit lines can be either secured or unsecured. A secured line is backed by collateral, such as business equipment, while an unsecured line doesn’t require collateral. Secured credit lines often have lower interest rates since the collateral makes them less risky to the lender, who can seize that collateral if your business defaults.
You won’t need collateral for an unsecured line, though these lines typically carry higher interest rates due to the increased risk to the lender. You may need better credit to qualify for an unsecured
How Disbursement and Repayment Works for Business Credit Lines
After approval, your lender will establish your business credit line fairly quickly. You can transfer these funds to your bank account or use a line of credit card to make direct purchases, much like you would with a debit card. Just be aware that business credit lines may have fees, such as draw fees or maintenance fees, and compare costs before you borrow.
Note that different lenders have different repayment options for business credit lines. For instance, some offer 6- or 12-month repayment terms and weekly or monthly repayment, while others offer repayment terms of 12-36 months and the option to repay credit lines daily, weekly, or monthly.
Business Line of Credit vs. Other Financing Options
Business lines of credit are a great option for many businesses, small and large, but other financing options are also available. Here’s a quick comparison.
Business credit lines | Business loans | Business credit cards | |
Interest rates | May be lower | May be lower | Tend to be higher |
Borrowing limits | May be higher | May be higher | Tend to be lower |
Repayment structure | Pay only if you owe a balance | Set monthly payment | Minimum monthly payment, though it’s best to pay in full |
Benefits | Flexible spending | Predictable payments | May earn rewards |
Best for | Working capital | Capital expenditures | Day-to-day business spending |
Business credit line
A business credit line could be ideal if you’re looking for flexible funding to cover working capital or other expenses. These credit lines tend to have more flexible repayment options than either business loans or business credit cards, and you’ll typically get lower rates than business credit cards and higher borrowing limits.
Business loans
If you have a specific amount you’d like to borrow for a new piece of equipment—a business loan may be a good alternative to a business credit line. A loan like this gives you lump-sum financing at a relatively low rate, and you’ll make monthly installment payments over a set term until your business loan is repaid. There are several types of business loans to choose from.
Business credit cards
Business credit cards tend to have higher rates than business credit lines or loans, and your credit limit may be lower. Thus, they’re often a better choice for day-to-day spending rather than large purchases.
That said, a business credit card with a 0% introductory APR could work well for a small equipment purchase, provided you pay it off before the introductory period expires. Many business credit cards earn rewards, which you could use for upcoming business trips or to offset your expenses.
Pros and Cons of a Business Line of Credit
As with any other financing type, there are benefits and drawbacks to business lines of credit. Here’s a look at the pros and cons.
Pros | Cons |
Flexible funding you can borrow against as needed | Interest starts accruing immediately |
Only pay interest on what you borrow | Your lender may require collateral |
Can draw from your line and repay multiple times | Credit limit may not necessarily be enough |
Lower rates than a credit card (typically) | May have draw and maintenance fees |
Higher borrowing limit than a credit card (typically) | No opportunity to earn rewards, as with a credit card |
Alternatives to a Business Line of Credit
Other alternatives to business credit lines include:
- SBA loans: Offered through the US Small Business Association, SBA loans are small business loans you can use to expand your business, purchase real estate, and more.
- Microloans: Ideal for entrepreneurs and newer businesses, microloans are relatively small business loans that can help you with startup or other costs.
- Invoice factoring: Factoring involves selling some of your accounts receivables to a third party for a fee to help meet immediate business cash needs.
- Crowdfunding: If you’re trying to launch a new business, crowdfunding—or getting small amounts of capital from many people—can help you get started.
Real-World Examples and Practical Tips
Business owners often turn to business lines of credit to smooth out their working capital over a short time period. For instance, maybe your business has seasonal dips in sales. You could draw from a business credit line during a lower-sale period to stabilize your cash flow and then repay your balance in full once things pick up again.
Bottom Line
Business lines of credit are flexible and tend to have low rates, and many lenders offer them. Financing like this is worth considering if you need a short-term source of working capital, though you’ll want to compare other options, such as business loans or credit cards, to determine which is best for you. Speak with a representative at your bank or a financial professional to narrow your options.
