Every small business must be ready to adapt to change, particularly during rapid expansion or fluctuating cash flow periods. An unsecured line of credit can be a good option when you need quick cash and have a lot of flexibility in repaying the money you borrowed.
For years, businesses have used credit lines to cover working capital needs and take advantage of strategic investment opportunities. Still, they haven’t caught on with individuals as well. Some of this could be because banks rarely promote lines of credit, and potential borrowers don’t think to inquire. A home equity line of credit, or HELOC, is the only credit line that might come up. However, this is a home-secured loan, which comes with its own set of concerns and risks.
What is a line of credit?
A bank or financial institution’s line of credit is a flexible loan. A line of credit is a fixed amount of money that you can borrow as needed and then repay immediately or over a certain length of time, similar to a credit card that allows you a limited amount of dollars that you can use when you like. A line of credit, like a loan, will accrue interest as soon as funds are borrowed, and borrowers must be approved by the bank, which is based on the borrower’s credit rating and relationship with the bank. It’s important to remember that interest rates are often fluctuating, making it impossible to forecast how much money you’ll end up costing you.
Secured vs. Unsecured business line of credit
There are two types of business LOCs — secured and unsecured. Here’s a look at the differences between the two.
Secured business line of credit
When you get a secured business line of credit, the lender typically puts a lien on the asset(s) you’re utilizing to get the money. The sorts of assets that a lender may take as collateral vary, but here are some examples:
- Real Estate (Business or Personal)
- Financial Securities (CDs, Stocks, Bonds, etc.)
It’s sometimes easier to qualify for a secured business line of credit than an unsecured one because you’ve put some money down. From a lender’s perspective, collateral minimizes risk and can make you a more appealing borrower.
However, putting up assets can do more than improve your qualification chances. Collateral may also assist you in getting better conditions from your lenders, such as cheaper rates, more considerable loan limits, and better terms.
Unsecured business line of credit
Many business owners, of course, prefer to obtain funding without putting their assets on the line. Some organizations, particularly startups, may not yet have any assets that a lender would consider acceptable. If you fall into one of these categories, an unsecured business line of credit might be a better fit for you.
An unsecured business line of credit functions similarly to a company credit card. You can borrow up to your account limit, and you can borrow against the same line of credit again in the future if you maintain the account effectively and pay on time.
With an unsecured LOC, you don’t have to put up any collateral to support the money your company borrows. On the surface, this sounds fantastic, and it can help you lessen the risk you’re taking on as a borrower, but think about the opposite side of the equation. Unsecured company LOCs are frequently more expensive than secured loans.
In most cases, less risk for you (the borrower) equals more risk for the lender. To compensate for the increased risk, unsecured business line of credit providers may:
- Increase your interest rates and expenses.
- Reduce your credit limits.
- Shorter repayment terms should be required (aka more significant monthly payments)
- Request that you sign a personal guarantee.
That isn’t to say that an unsecured business LOC isn’t a viable option. Just remember to weigh the benefits and drawbacks of each company finance option before deciding.
Business line of credit requirements
A line of credit will be one of your most versatile options among all the business loans and other funding options available.
You get a credit line in a certain amount with a business line of credit, and you can draw funds (in any quantity, up to your limit) anytime you need them. You’ll have to repay the funds you took out, and you’ll only be charged interest on those sums.
If you need money for your business, whether to sustain cash flow, buy merchandise, or upgrade equipment, a business line of credit can be a good option.
The following are the prerequisites for a business line of credit:
- Ideally, it would be best to have a credit score of 660 or better.
- Annual income $25,000 or more
- Ideally, you should be in business for at least six months.
- To secure your line of credit, you’ll need collateral.
- Debt repayment schedule: To see if you can afford to repay the line of credit if you take it out.
- Information about yourself and your business: A form of identity, as well as your EIN, if applicable.
Seven things to know about a business line of credit
If you decide to use a business line of credit, you should be aware of a few facts. The following tips may assist you in avoiding future issues.
- Know the difference between a secured and unsecured line of credit
You can choose between a secured and an unsecured line of credit. A secured line of credit is when assets owned by your company back up the amount you borrow. The lender takes ownership of these assets if the borrower defaults on payments.
An unsecured line of credit, on the other hand, does not require any specific assets as collateral for the amounts borrowed.
Because your assets back the line of credit, you may be eligible for a more significant amount of money with a secured business line of credit. It’s also possible that the interest rate will be reduced.
An unsecured business line of credit, on the other hand, has the advantage of allowing you to access funds more quickly. This is because the application process is usually more straightforward, but you’ll most likely pay a higher interest rate.
2.Pay attention to potential fees
You’ll very certainly be charged transaction fees every time you borrow from your line of credit, in addition to interest and withdrawal repayment. These costs can mount up if you use your company line of credit numerous times throughout the year.
Depending on your lending institution, you may be charged a maintenance fee for your account even if you don’t use it. Make sure you read all of the fine print regarding costs, so you don’t get caught off guard.
3.Be aware of potential bank drawdowns on an existing business line of credit
During times of economic instability, the lending institution may, at their discretion, require you to repay the balance on your line of credit. If you have a loan arrangement with a lending institution, be aware of this specific provision.
Consider what you would do if you were in this circumstance. A business line of credit may harm your company’s financial status if you can’t afford to repay the loan on short notice.
4.Be prepared for interest-rate variability
The interest rate on a line of credit is usually variable. It’s based on a higher or lower percentage than the prime lending rate.
You may find it challenging to repay your line of credit if interest rates rise. Because obtaining money through a line of credit is relatively simple, you may find that you have less control over your expenditures. And, when interest rates rise, this could put you in financial trouble as your debt grows.
5.Look into insuring your business line of credit
You might want to consider purchasing insurance to protect a business line of credit.
In the event of a severe sickness, injury, or death, insurance can assist you in making overdue payments on your business line of credit. This could be critical protection for you and essential members of your organization, depending on the size of your line of credit.
6.Know the criteria for evaluating the best line of credit
It can be tough to find the best option from the many lending organizations that offer a company line of credit. Interest rates differ from one lender to the next. Thus, this is one of the most important factors to consider. Next, check the borrowing limitations to ensure that you have enough credit to satisfy your future needs.
You should also consider the repayment conditions to see if they meet your needs. The terms of repayment vary widely, ranging from weekly to monthly. One size does not fit all when it comes to credit lines. To avoid unpleasant shocks, do your homework.
7.Consider the help available from the Small Business Administration
The Small Business Administration has a program that can assist small-business owners in obtaining a credit line.
While they do not lend money directly to you, their program can help you access funds. They achieve this through their Lender Match program, which connects you with lenders willing to lend you money. This could simplify the procedure of acquiring a line of credit.
Where to get a business line of credit
Banks and credit unions
Different forms of business credit lines, such as secured and unsecured business lines of credit and SBA lines of credit, are available from banks and credit unions.
Although these lenders can provide business lines of credit with low-interest rates, you’ll usually have to meet a set of criteria to be approved. You’ll probably need a lot of money, good credit, and a lot of experience.
Banks and credit unions, in comparison to online lenders, are more likely to need physical CollateralCollateral to secure your credit line (particularly for more significant limits) and to collect additional costs, such as yearly and inactivity fees.
Online lenders like BlueVine and Fundbox have more flexible qualification standards than banks and credit unions. Some internet lenders are willing to engage with new firms or weak credit.
Small-business lines of credit can be issued in as little as a few days, thanks to online lenders’ simplified application processes and lower fees. On the other hand, these lenders are more likely to charge higher interest rates and have smaller credit limits than banks.
Business line of credit rates and lenders
You might apply for a business line of credit from a regular bank or a non-bank internet lender, frequently offering fewer qualifying conditions and faster funding times than banks. Here are several lenders who can assist you in your hunt for a business line of credit.
Based on the ease of prerequisites and time to funding, this list exclusively contains internet lenders. The following criteria guided our selection of the finest lines of credit:
- Amounts between $100,000 and $250,000 are the maximums.
- A minimum credit score of 650 or less is required.
- Lender websites provide detailed information on quantities, rates, and periods.
|Wells Fargo||Unsecured business lines of credit||$5,000 – $100,000||Prime rate + 1.75%-9.75%||Up to 5 years, depending on loan type|
|Fundbox||New businesses and startups||$1,000 – $150,000||4.66% – 8.99%||12 – 24 weeks|
|Credibly||Poor credit||Up to $250,000||Starting from 4.80% interest rate||26 weeks|
|OnDeck||Fast funding||$6,000 – $100,000||35.9% – 47.14% APR||12 months|
Lenders offering unsecured business lines of credit for startup
Here is the sampling of brands offering unsecured business lines of credit for startups. The chart provides critical information about each lender.
|Lender||Rates start at||Minimum Time in Business||Credit Score Required||Line of Credit Limits|
|Wells Fargo||Prime + 1.75%||BusinessLine®: 2+ years; Small Business Advantage®: less than 2||Information not publicly available||$100k|
|SunWise Capital||12.99% to 15.99%||1 year||700+||$200k|
Personal guarantees on unsecured LOCs
Lenders will only approve company funding applications if they are comfortable with the risk involved. If you don’t have any collateral to put up as security for a company line of credit, you may be required to sign a personal guarantee instead.
A personal guarantee (PG) effectively turns you into a co-signer on your company’s credit line. When you sign a PG, you’re guaranteeing to reimburse the obligation if your company fails to do so. If you’re not putting up an asset, it’s another way for a lender to ensure that you, the business owner, have some skin in the game.
(Note that some secured business lines of credit may also require personal guarantees.) Before applying for a line of credit or another sort of financing, read the fine print and ask any lender questions about individual guarantee requirements.)
Tips for comparing business lines of credit
Consider these tips when comparing business lines of credit:
- Prequalify wherever feasible: A prequalification process is available from several business funding lenders. This means that potential borrowers can share information about their financing needs, income, and other pertinent data to see what loan amounts, rates, and payback terms they might be eligible for. This usually only necessitates a soft credit inquiry, which has no bearing on your credit score.
- Consider the payback terms as well as the degree of flexibility: Each company loan provider has its own set of repayment terms. Some types of financing require monthly payments, while others may require charges every day or every week. When selecting your chosen business line of credit, keep this in mind.
- Keep an eye out for hidden costs: Some lenders provide no-fee business loans, which eliminate the need for borrowers to pay origination fees, late fees, prepayment penalties, or any other customary loan costs. This isn’t always the case, though. When looking for the best terms, double-check a lender’s cost structure. Consider additional charges before making your decision.
- Examine the customer service choices provided by the lender: Consider the lender’s support alternatives before signing the loan agreement if you’ve discovered a lender willing to lend you the money you need in favorable conditions. If you have problems with repayment, having good customer service can make a big difference. Look into the lender’s customer service resources and read reviews to ensure it’s a good fit.
The problems with lines of credit
Lines of credit, like any other lending instrument, have the potential to be both valuable and hazardous. If investors take out a line of credit, they must repay it (and the terms for such paybacks are spelled out at the time when the line of credit is initially granted). As a result, a credit evaluation process is in place, and would-be borrowers with poor credit will have a considerably more difficult time getting accepted.
It’s hardly free money, however. Unsecured lines of credit—that is, credit not secured by your home or other valuable property—are less expensive than pawnshop or payday loans and usually less expensive than credit cards. Still, they are more costly than standard secured loans like mortgages or vehicle loans. The interest on a line of credit is usually not tax-deductible.
If you don’t use your line of credit, some banks will charge you a monthly or annual maintenance fee, and interest begins to accrue as soon as money is borrowed. Because lines of credit can be drawn on and repaid on an ad hoc basis, some borrowers may find the interest calculations for lines of credit to be more confusing, and they may be shocked by the amount of interest they wind up paying.
Business lines of credit Vs. Other financing methods
While a company line of credit is ideal for certain expenses, other types of financing may be more appropriate in different situations.
Business line of credit vs. Small business loan
Unlike business lines of credit, small business loans are issued as a lump sum of money. After receiving the funds, you must repay the loan in periodic payments, including interest on the total amount borrowed, over a defined period—typically between six months and 25 years.
Small business loans are great for large purchases and running needs, whereas business lines of credit are great for a rainy day fund.
Business line of credit vs. Business credit card
A credit card provider issues you a credit limit that you can borrow from as needed, similar to a business line of credit. On the other hand, business credit cards usually have lower credit limits. As a result, credit cards are ideal for small, everyday company purchases.
Qualification standards for business credit cards also vary. When you apply for a business credit card, your issuer will usually look at your credit score, making them a good choice for new business owners or sole proprietors who don’t have much track record.
On the other hand, business credit cards frequently have higher interest rates than business lines of credit. You may be eligible for an interest-free promotional term on purchases and balance transfers if you have good to excellent credit. You can avoid all interest costs if you pay off your balance in full before the month ends.
Frequently asked questions
When is a business line of credit a good idea?
When you need to finance short-term obligations like replacing inventory or covering unforeseen costs, a business line of credit is the ideal option. On the other hand, a small-business term loan is used to pay for substantial, one-time expenses such as equipment acquisitions.
A business credit card can offer many of the same advantages as a business line of credit, including repeat funding and the chance to establish business credit. A business credit card for bad credit can help you get started if you have thin or poor credit.
Which type of lender is best for a business line of credit?
Business lines of credit are available through online lenders, banks, and credit unions. Banks and credit unions often require substantial revenue and at least a few years of experience to qualify for a loan. Online lenders have fewer requirements, but they may demand higher interest rates. Compare your alternatives to see which one best suits your finance requirements.
Is it hard to get a business line of credit?
Obtaining a small-business line of credit can be challenging for newer enterprises. To get any form of financing, traditional lenders, such as banks, often demand enterprises have several years of operations, revenue, and excellent financials.
The bottom line
To cap it all, a business line of credit, like any other financial product, is neither good nor harmful inherently. It all comes down to how individuals use them.
On the one hand, excessive borrowing against a line of credit, just like excessive credit card expenditures, might put a person in financial danger. On the other hand, a business line of credit can effectively fund expansion and other profit-generating projects. They provide financial flexibility to address gaps in regular cash cycles, can be used to harness resources to continue year-round business operations for seasonal enterprises, and can be used to support expenses that add value and enhance performance when used in conjunction with other financial tools.