Most people have a credit card. Chances are you have one for yourself or your business, so you’re familiar with how simple and easy they are to use. Business lines of credit work in a similar way. Using credit for your business can be a great idea to boost your financial health and fund large purchases.
A line of credit isn’t technically a loan. It’s an agreement that establishes a maximum amount a business can borrow. A line of credit can be accessed at any time as needed as long as it doesn’t exceed the maximum limit. Interest is only paid on the money used, and once it’s paid back, you can use it again – much like a credit card.
And like a credit card, the lender sets a maximum amount and the business can draw from it using either checks or a card. Borrowers can request a certain amount, but they don’t have to use it all. This flexibility is the main appeal of a line of credit, which is the most ideal for emergency funds – just in case something happens and you need your cash quick. This can help you avoid taking out working capital loans, or “payday” loans, with incredibly high interest rates.
Like using any form of credit or money that isn’t technically yours, they can have limitations and certain dangers, so it’s advised that they’re used responsibly.
Do You Qualify?
Qualifying for a line of credit is a little easier than other loans, but there are many variables associated with getting one. The maximum amount, duration, repayment terms and interest all depend on your business’s already established credit and revenue. Usually, new businesses may be able to qualify for smaller lines of credit while more well-established businesses can receive larger lines of credit.
How to Apply
Like most loans, you can get a line of credit at a bank or an online lender. Banks have long, intensive line of credit applications – they require a lot of paperwork and wait time. Online lenders will offer quicker, easier applications (and chances for approval), but will often have higher interest rates. You’ll need all the basic documentation to apply:
- Valid driver’s license
- Voided business check
- Bank statements
- Balance sheet
- Profit & loss statements
- Credit score
- Business tax returns
- Personal tax returns
What About a “Revolving Line of Credit?”
Line of credit financing is sometimes referred to as “revolving” because it usually doesn’t require you to apply again and again for a loan. This definitely comes in handy. Once you pay off what you’ve spent within your credit limit, you can use up to that limit again without applying again. It’s always there, and you don’t have to worry about filling out all the paperwork each time you pay it off. This is part of the allure of a line of credit – you save time, energy and stress by not having to apply for multiple financing options.
How do They Compare to Other Loans?
Business lines of credit traditionally have lower interest rates and closing costs, but can be pretty big on punishment. They have strict repercussions if you exceed your limit or miss a payment. Traditional loans, too, are usually used more for one time, larger purchases – like a company car. Lines of credit are best suited for repeated spending or cash flow. This doesn’t mean you can’t make large purchases with a line of credit, but often, traditional loans are better options for these types of expenditures because their interest doesn’t vary depending on what you spend.
Since business lines of credit are so flexible, they’re really attractive to use for recurring expenses. Things like:
- Operating expenses
- Cash flow gaps
- Emergency funds
- Seasonal expenses
Do They Have Term Lengths?
No, lines of credit don’t usually have term lengths, but they do have different maximum amounts depending on where you get them. Online lenders usually will only offer small- and medium-amount lines of credit. These both don’t really have term lengths, but the “small” and “medium” refer to the maximum amount of money you can withdraw. You can withdraw and pay back funds whenever you want. Larger-amount lines of credit are usually only given out by traditional banks.
So how do They Compare to Credit Cards?
It’s true that they’re both forms of revolving credit, but credit cards have several limitations that lines of credit don’t.
- Credit cards are typically paid monthly. Lines of credit usually are not.
- Credit cards typically have higher interest rates.
- Credit cards charge fees for cash advances and balance transfers.
- Lines of credit give you access to cash. Credit cards do not.
What Will It Cost You?
Interest rates are set by the lenders and the market rates, and they vary widely according to your business specifics. However, these rates are often lower than a business credit card.
To help understand the costs associated with lines of credit, here’s an example:
You run a restaurant in a small college town. During the summer, when all the students head home or to internships, you have a lull in your business. In order to pay your expenses in June, July and August, you need some extra cash. You know that after these three months, your business will pick up significantly. So, you apply for a $25,000 line of credit.
With it, you end up spending $20,000 on your rent, payroll and supplies for those three months. If your interest rate was 10%, you’d pay back that $20,000 plus 10% in interest, for a total of $22,000. Once you pay that off, you have $25,000 again and you can keep it to use when you have other lulls in business, like winter break.
This can all sound very overwhelming, but that’s why we’re here. When you sign up with FaasFunds, we analyze your business needs and finances and figure out if a business line of credit is the best option for you. We’ll also link you up with an industry expert to help you through tough financial decisions. Navigating the financial world is tough, so make it easier with FaasFunds.