What Is a Business Line of Credit?
A business line of credit is a flexible loan that provides you access to funds as needed. Rather than borrowing a fixed amount upfront, a line of credit gives you access to a maximum amount, say $50,000, that you can draw from as needed.
Interest is only charged on the amount that you actually borrow. As the principal is paid back, your credit line becomes available once more for upcoming requirements. This revolving credit line can be used to support seasonal swings in business or to provide emergency funding.
You must apply with a bank or credit union in order to be eligible for a business line of credit. Based on your credit score and level of risk, they will evaluate your company’s financials to establish a lending limit and interest rate. Better terms are expected the higher your score and the smaller the danger.
Once approved, you can use a credit card, write checks, or set up automatic transfers to access the funds. To keep yourself out of default on the debt, make consistent payments of the lowest possible amount. The excess payment reduces interest paid and shortens the payback period.
Benefits of a Business Line of Credit Loan
A business line of credit loan offers some sweet benefits for your company.
1. Flexibility.
With a line of credit, you only borrow what you need, when you need it. You have access to funds on demand, so you’re not paying interest on money you’re not using. As your needs increase or decrease, you can draw from the line of credit or pay it back without penalty. This flexibility allows you to act quickly on new opportunities.
2. Low fees.
The upfront costs associated with lines of credit are usually cheaper than those of alternative borrowing options. If you pay it off early, there are no prepayment penalties; however, there can be a yearly maintenance fee to keep the service open. It also frequently has a lower interest rate than credit cards.
3. Build business credit.
By using and repaying a line of credit, you establish a good payment history with the lender. This helps strengthen your business’s credit and improves your chances of qualifying for other financing in the future on the best terms.
4. Convenience.
With a line of credit, the funds are there when you need them. No more waiting for approval and funding with each new loan. Once approved for the line of credit, you have ongoing access to capital to run and grow your business.
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How to Qualify for a Business Line of Credit
To qualify for a business line of credit (LOC), you’ll need to meet the following criteria.
1. Stable cash flow
Lenders require proof that your company makes enough money to cover the loan over time. To prove your cash flow, submit your last two years’ worth of tax returns, balance sheets, profit and loss statements, and cash flow statements.
2. Good business credit
Before applying for a Line of Credit, be sure there are no errors or indications of bad credit on your company’s credit report or score. If necessary, take action to raise your score. Generally speaking, lenders prefer to see a score of 650 or greater.
3. Solid collateral
Some lenders may require you to pledge collateral, like business equipment, vehicles, or property to secure the LOC. Make sure you have assets to put up as collateral in case you default on the loan.
4. Experience and credibility
Your experience, skills, education, and reputation in your industry can inspire confidence in lenders. Be prepared to provide details about your business’s history, goals, competitive advantages, key accomplishments.
5. Equity in the business
Businesses with a minimum of two to five years of operation are preferred by lenders. They desire a significant ownership stake or investment in the business. Prepare documentation attesting to the amount of capital or funds you invested in starting and expanding your company.
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Comparing Business Line of Credit Lenders
When comparing business line of credit lenders, there are several factors to weigh.
1. Interest Rates
Compare the interest rates offered by different lenders. Lower rates mean lower costs for your business. Some lenders may charge a fixed interest rate, while others offer variable rates tied to the prime rate. Variable rates are riskier since your payments could increase, but may start lower.
2. Fees
Look at any fees charged, like application fees, origination fees or annual fees. Some lenders charge no fees, so shop around. Fees reduce the amount you actually receive and cut into your bottom line.
3. Loan Amounts
Make sure the lender offers a line of credit in the amount you need. Typical lines range from $10,000 up to $500,000 or more. If you need a large amount, check that the lender has the ability to fund a line that big.
4. Repayment Terms
Check how long you have to repay any amounts you draw on the line. Most lines are revolving, meaning as you repay amounts borrowed, that money becomes available to borrow again. But some lenders may require full repayment after 6-24 months. Longer terms, like 2-5 years, give more flexibility.
5. Qualifying Criteria
Review what requirements the lender has for approving your application. Typically, you’ll need a decent credit score, 2+ years in business, and a healthy cash flow. Some lenders cater to startups or businesses with lower credit scores, but may charge higher rates. Make sure you meet their criteria before applying to avoid wasting time.
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How To Use Your Business Line of Credit Wisely
Once approved for a business line of credit, it’s important to use it responsibly. The following are ways to use it wisely:
1. Only Borrow What You Need
Only access the amount of funds you need for a specific business purpose. Don’t treat it like free money just because you have access to it. Borrowing more than necessary means paying additional interest charges and can reduce your available credit for when you really need it.
2. Make Regular Payments
Even if it’s a revolving line of credit, make at minimum the minimum monthly payments. Paying only the minimum means much more of your payment goes toward interest, reducing the principal balance more slowly. If possible, pay more than the minimum to lower your balance faster and reduce interest paid.
3. Don’t Max It Out
Try not to borrow up to your maximum credit limit, if possible. Keep some of your line of credit available for unforeseen circumstances. Maxing out your line of credit can hurt your business’s credit utilization ratio and credit score. It may also trigger a freeze on your line of credit until your balance is paid down.
4. Track Your Balance and Payments
Monitor your line of credit regularly to ensure payments are made on time and your balance remains at a responsible level. Late or missed payments severely damage your credit and may cause penalties or a default on the line of credit. Staying on top of your balance also allows you to borrow strategically.
Conclusion
Using your business line of credit responsibly by borrowing only what you need, making regular payments, maintaining a safe balance, and closely monitoring activity will help ensure this financing tool benefits your company for the long run.
