Understanding Business Lines of Credit
If you’re looking to secure small business funding, you have several options when it comes to securing a loan. One such option is a line of credit. With a business line of credit, you have a type of revolving credit that operates similarly to that of a credit card. Instead of the lump sum you get with a term loan, a line of credit provides your business with a credit limit that can be drawn upon when needed.
How Does It Work?
With a term loan, you have a lump sum that has to be paid back over a fixed period. On a line of credit, the business has access to funds that can be used and then repaid as needed.
For example, if your business has a $100,000 line of credit, it means you can access those funds whenever necessary. You’ll also only have to pay interest on the funds you use. If you use $20,000, you still have an additional $80,000 that can be used, and you only have to pay interest on the $20,000 that was borrowed. Once the funds are repaid, you once again have access to the full credit line of $100,000.
Like any type of loan, some of the details can vary depending on factors that are specific to the lender and borrower. Businesses can find lines of credit that range from as little to $1,000 to as much as a $1,000,000. Interest rates can also vary depending on the lender and the borrower. You may also find variables to the repayment schedule that range from as little as six months to a few years.
What Is It For?
Unlike term loans, once you have secured a line of credit, it can be used for almost any business expense. However, there are things you should consider when deciding whether to use a line of credit to fund your business.
For the most part, a business line of credit is good for having quick access to funding when you need it. If you need to cover your payroll, pay for an unexpected expense or take advantage of a business opportunity, a business line of credit is good for that sort of short-term financing.
If you have a larger expense with less urgency, it is better to look for something like a term loan. Term loans tend to have lower interest than lines of credit, and most lenders will allow you to pay a term loan back over a longer period. With lower interest and more time for repayment, a term loan will be easier for a small business to manage when the loan is large.
What Are the Qualifications?
There was a time when it was much more difficult for small business owners to secure a line of credit. Due to innovations like online lending, there are now more options than ever for securing a line of credit, and this has made it easier for small businesses to obtain this type of funding.
While the exact requirements will depend on the lender, there are some general points that make a business qualified for a line of credit.
You will need to be in business for at least six months. Some banks may even require a few years of operations for a business to qualify.
You are also going to need to demonstrate strong, reliable revenue to get a business line of credit. At a minimum, you would need to prove that your business earns at least $25,000 in annual revenue. However, this figure varies considerably depending on the lender.
You will need to have a personal credit score of at least 500. Your credit score can also have a significant impact on the credit limit and the amount of time you will have to pay back the funds. For that reason, some business owners might want to work on improving their credit score before trying to secure a line of credit.
Securing a Line of Credit
The process of securing a line of credit will vary depending on the lender. If you go with a bank, the requirements will be stricter and they are likely to require more documents. If you go with a short-term lender, the process might be simpler, but you are probably going to pay higher interest while your credit limit will be lower.
Before applying for a business line of credit, you should try to prepare the following:
- Bank Statements
- Personal and Business Tax Returns
- Balance Sheet
- Profit and Loss Statements
- Credit Score
When trying to secure a line of credit, it is a good idea to compare several options to find the one that is the best fit for the needs of your business. Take the time to understand the requirements of different lending options and learn about the obligations that come with taking a line of credit from different lenders.
Contributed by Rae, a graduate of Tufts University with a combined International Relations and Chinese degree. After spending time living and working abroad in China, she returned to NYC to pursue her career and continue curating quality content. Rae is passionate about travel, food, business development, entrepreneurship and writing, of course.