How Does a Business Line of Credit Work?
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Perhaps now more than ever, many small businesses, in particular, are experiencing cash flow issues. With uncertain economic times impacting numerous companies across the nation, businesses are simply trying to figure out ways to make it through and ultimately survive. One solution that seems to be helping many during this challenging period is a business line of credit. Often easier to get than say a short term loan or even an SBA loan, a line of credit offers the flexibility and funds that companies need right now. In this article, we take a look at some of the basics associated with a business line of credit.
Understanding how a business line of credit works
As noted, a business line of credit is an extremely flexible financing solution, as you are approved for a certain amount but don't necessarily have to take all of it. And you also have the ability to keep that money on hand for future needs. In approving a company for a line of credit a lender will look at factors such as revenue, cash flow, and current debt.
You might compare a business line of credit to a credit card. That is to say, there is no fixed monthly/weekly repayment schedule. When you use funds from your line of credit, that is when you will need to make payments. Once you pay back the amount borrowed then that money is again available for you to use. This is also why a business line of credit is also referred to as a revolving line of credit. And the good thing about this type of funding is that you can in fact pay it off early without any sort of penalty or additional fees. It really is among the most flexible financing options out there.
As far as interests go when dealing with a line of credit, you are charged on the amount you take out, not on the entire amount for which you are approved. Keep in mind, that some lenders do charge a monthly maintenance fee for having your account sit unused. This is why it is critical to read all of the details concerning your line of credit terms.
Secured vs. unsecured lines of credit
With a secured line of credit essentially what this means is that the borrower is offering to put down collateral to in effect secure that line. So this could potentially take the form of real estate or it could also be inventory for example. For a lender, a secured business line of credit is preferable as they now have less risk associated with the loan. Should the borrower default, the lender always has the collateral that they can then seize and thus use to recoup some of the loss. To this end, secured lines of credit generally have lower interest rates attached because again, there is less risk involved. If your company is relatively new or if your credit score isn't where it needs to be, you may have no option but to go with a secured line depending on the other factors evaluated.
An unsecured line of credit then is one in which the borrower is not required to put down any sort of collateral or deposit. Here though there is more risk involved so the interest rates can be higher with this type of line. Often if a business has been operating for a number of years and has a solid track record, they will qualify for an unsecured line of credit.
When can you use a line of credit?
There are certain circumstances where a short term or SBA loan may be a better option. You have to consider what you need the funds for and consequently how/when they are going to be used. Some instances in which a business line of credit makes more sense:
- If yours is a seasonal business and there are slower times of the year, then potentially a line of credit could work perfectly to help during the more sluggish sales periods.
- If in light of the nature of your business, clients take longer than thirty days to remit payment, you could use a line of credit in the interim.
- If there are certain bills that it benefits you to pay early, a line of credit could also help you in this capacity.
How do you qualify
As with many business financing solutions, a lender is going to look at a variety of factors in order to determine whether or not you qualify for a line of credit. Credit score, time in business, annual revenue, cash flow position are all among the items they will take a look at. The more information you can provide, the more documentation showing the strength of your company, the better your chances will be of procuring a loan. If you are able to offer collateral and thus get a secured line, this will also help your chances of getting approved for the line of credit. Keep in mind, that the best time to apply for a business line of credit is before you actually need it. This way you give yourself a cushion and so when the need for additional cash does arise, it is right there ready for you to use. In other words, don't wait until you're experiencing cash flow problems to apply for a line of credit. Because if you do find yourself in a difficult financial position, your loan application becomes less attractive to lenders.
First Union Lending is here to help. We offer numerous financing programs all designed with small businesses in mind. We want to see our clients make it through this challenging time and ultimately thrive. Our business loans are fast and flexible—some receive the cash in their accounts within two days. We understand that you need money now, not weeks or months from now. With products ranging from 5k to one million, we have the funds on hand to help. Call today!