With a business line of credit you can access funds when you need them and only pay interest on money withdrawn, not the entire facility amount.
What is a Business Line of Credit?
A business line of credit is a facility that gives a business the ability to draw from and payback to an available amount of pre-approved credit limit. Money drawn from the credit line is deposited as cash to your operational account and then the available credit left in the line is adjusted. As the credit line is paid back through monthly payments, the available amount of credit is increased. A line of credit works similarly to a traditional credit card, where purchases reduce the available credit and payments towards a credit card increases the available credit and decreases the credit balance (money owed from purchases).
A business line of credit is one of the most popular forms of financing for a business, because it affords ease when funds are needed. Also the payback terms and interest rates are generally lower than small business loans. This being said, most businesses are often not qualified for this type of credit due to time in business and other factors. Since this type of financing is generally unsecured, the business and business owner face more underwriting scrutiny during the application process.
The use of a line of credit is endless, whether cash is used for materials, equipment or just general working capital. Some businesses use a line of credit to help finance the business as they await customer payments to arrive. Once their accounts receivables come in, they pay off the withdrawn money to avoid unnecessary interest charges.
How does a Business Line of Credit Work?
As the line of credit is used, you pay down your debt in monthly payments until the line is replenished to the original credit limit. You are only charged interest on borrowed debt on a monthly or weekly amortization schedule, so you can elect to pay back the withdrawn funds early to catch a break on interest costs. Depending on the bank there may be draw fees, which are charged each time a draw is activated. Also depending on your draw activity, there may be monthly or yearly maintenance fees with a line of credit.
A revolving credit line is constantly replenished as the debt is paid down. Revolving lines are the most common form of a business line of credit, since a non-revolving line is more like a business loan with fixed payments and the fact that money is not available as the line is paid off.
Business lines of credit can be secured or unsecured. Secured business lines of credit require an asset that the lender uses as collateral during the repayment period. The most common assets used to secure a business line of credit are: Real Estate, Accounts Receivable, Inventory or Equipment. An unsecured business line of credit is not secured with any asset. The rates on secured and unsecured vary depending on the bank, but a good rule of thumb is that a debt that has collateral is less expensive than with no collateral.
Unlike a credit card, business lines of credit have certain timeframes where the entire line has to be paid down to a certain amount, usually zero dollars ($0.00 balance) within a couple of years. Once the line is paid down, businesses can elect (if re-qualified) to reactivate the line of credit or (if the lender allows) term out the balance in the form of a loan.
The cost of lines of credit depend on the creditworthiness of the business as well as the bank rates. Most businesses experience anywhere an annual rate of 4% to 8% for a bank business line of credit.