4 Ways to Know if a Business Line of Credit is Right for Your Company
If you think your business will benefit from additional working capital but find many types of small business loans limiting or too rigid, a business line of credit (LOC) may be worth a look.
A line of credit is a flexible funding option. Like with a business credit card, you can borrow up to a certain limit set by the lender and a LOC also offers revolving credit, which means once you pay the borrowed amount plus the interest, the limit is reset. Furthermore, you only have to pay interest on the borrowed amount.
Unlike a credit card, however, the LOC’s interest rates are lower and you can use it to pay for things that credit cards cannot pay for, such as payroll. Sure, you also can get a cash advance from a business credit card, but that comes with a high fee.
Let’s say that you have a line of credit that has a $20K limit. If you draw $5K from it, you will have to pay interest only on the $5K you borrowed, and the remaining $15K will still be available for you to use in the future. After paying back the $5K and its interest, you will once again have a credit limit of $20K.
So far, so good, right? A business line of credit sounds wonderful, but how do you know if it is right for your company? Here are four questions you should ask yourself.
1. How much money do you need?
The borrowing limit of a line of credit is usually lower than those of term loans, especially if not backed by collateral. This makes a line of credit more suitable for short-term cash flow needs, such as buying inventory or equipment or making payroll, rather than big expenses, such as starting a new branch. If you need a big amount that you will repay over a long time, you will need a different kind of business financing.
2. Do you have a poor or insufficient credit history?
You can still get a line of credit even if your credit score is less than ideal or your business is new. You might not be able to get a LOC from banks but there are many online lenders that have low or no credit score requirements and welcome businesses that are only a year old or even newer.
In addition, being responsible with your line of credit can help you get approved by online lenders for a business line of credit higher loan amounts, and better interest rates and repayment terms if you need to borrow money in the future.
3. How soon do you need the money?
Traditional business loans require a lot of paperwork and take a long time to get approved. In contrast, getting approved by online lenders for a business line of credit only takes a few days. Moreover, once you already have an existing LOC, you will have cash immediately available as long as you don’t go over the limit.
4. Do you need more freedom on how you can spend the money?
Some types of small business loans can only be used for certain things and not for others. An SBA CDC/504 loan, for example, can be used to buy machinery or renovate facilities but not for working capital or buying inventory. A line of credit, however, can be used for any business purpose.
Also, you have to pay interest only on the money you use, not the whole loan amount. Because of this, you can have money available to prepare for lean times or emergency expenses without worrying about having to pay interest on the idle funds.
The bottom line
A business line of credit is a very useful tool you can use to inject additional capital to your business. Just as with any kind of debt, terms vary so be sure to read the fine print before choosing a lender and signing an agreement.