As a business owner, you have to be ready for the unexpected, good or bad. Whether it’s a new project with a dream client that will have a lot of upfront expenses but be worth the potential payday, or a slow down of your business that requires extra funds for payroll.
For small expenses, dipping into savings and using a business credit card might be enough. However, a business line of credit can offer a much higher credit limit and lower interest rates than credit cards. Although you’ll need to apply and get approved as you would with a business loan, you don’t have to borrow money or pay interest until you use your account.
What is a business line of credit?
A business line of credit (LOC) gives you the option to take out a loan, known as a draw, but doesn’t require you to take out a loan when you apply. If approved, your account will have a maximum credit limit. You can then take out a single loan, or a series of loans, against your credit limit and will only pay interest on the amount you borrow.
Lines of credit vs. installment loans
You can also borrow money with a business loan rather than a line of credit. However, with a loan, you receive the entire loan amount upfront and then repay it over a specific period. The loan starts to accrue interest right away, and you need to apply for a new loan if you want to borrow more money.
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Lines of credit can offer more flexible financing because you can choose when and how much to borrow. You can also usually pay down your balance, freeing up your available credit and allowing you to take more draws without reapplying. However, the lender may periodically review your account, finances, credit, and general market conditions to determine if it wants to change your credit limit or interest rate.
Types of lines of credit available to businesses
You can apply for either a secured or unsecured line of credit. They generally work the same way once your account is open, but there is an important difference:
- Secured business line of credit. A secured credit line requires collateral, such as business equipment, accounts receivable or a blanket lien on your business. The lender can take or sell the collateral to cover any unpaid debts. Small business owners may also need to sign a personal guarantee, which means you promise to repay the loan if the business doesn’t.
- Unsecured business line of credit. Unsecured lines of credit don’t require collateral. Instead, your approval and terms will depend on your business’s creditworthiness, which may include its credit history, credit score, and financial position. The owner’s creditworthiness also often is a factor for small businesses.
It might be easier to qualify for a secured LOC, and you may receive more favorable terms, but you risk losing your collateral. Creditors can sue you if you default on an unsecured LOC, but they won’t be able to immediately claim your assets.
There are also revolving and, less commonly, non-revolving credit lines:
- Revolving lines of credit. Let you repeatedly take out and repay loans without applying for a new LOC—a credit card is a type of revolving credit line.
- Non-revolving lines of credit. You can still choose when and how much to borrow, but your credit limit determines the total amount you can borrow.
Although they don’t have different names, lenders can also set up business lines of credit in different ways.
Traditional lines of credit have a draw period, which is when you can take out loans and only have to make small (or no) payments. After that, the repayment period begins, and you repay the outstanding balance based on your repayment terms.
Some lenders alternatively offer business lines of credit that don’t have draw and repayment periods. Instead, each draw you take out has its own repayment schedule and period.
8 requirements to get a business line of credit
Lenders can set the requirements for their lines of credit, but there are a few categories and factors that lenders tend to consider:
- A business entity. Some lenders offer business lines of credit to sole proprietors, but others only lend to incorporated and registered businesses.
- Good credit. Your personal credit history and scores, along with your business’s separate credit history and scores, can be factors.
- A personal guarantee. If you have a small business or are a sole proprietor, you may need to sign a personal guarantee.
- Revenue. Your business may need to meet minimum monthly or annual revenue requirements, and this can have an impact on your LOC’s credit limit.
- Years in business. Traditional lenders generally require that a business have at least a two-year operating history to qualify for an LOC, but online lenders may offer an LOC to a newer business.
- Your business’s industry and size. Lenders might automatically reject businesses that are part of risky or heavily regulated industries. The size of your business can also play a role in its eligibility.
- A business plan, financial statements, and loan proposal. Lenders may want to review your business plan, financial statements, and how you plan to use the loan before agreeing to lend you money.
- Collateral. You’ll also need to have collateral to pledge to the lender if you’re applying for a secured LOC.
Open a business line of credit in three steps
Applying for and opening a business LOC is similar to establishing other types of credit accounts. You may be able to start the research and application process online. Some lenders require you to visit a local office to complete the application, while others offer a completely online process.
- Review your needs and eligibility. Figure out how much you expect to borrow and review the requirements listed above to see where you stand. Checking your personal and business credit reports and scores could be a good idea.
- Compare lenders. Look into traditional and fintech lenders to see who offers lines of credit that you’ll likely qualify for and compare how the lines of credit work. Try to narrow down your selection to a handful of top picks based on their loan amounts, interest rate ranges, repayment terms, and fees.
- Apply. Follow the lender’s requirements for submitting your application. You may need to agree to a personal credit check and share copies of documents to verify your information, such as your identification, business licenses, bank statements, financial statements, and tax returns.
Once you open your account, you may receive checks or a card that you can use to access your credit line. Or, the lender may transfer your draws directly to your business bank account.
What to know before getting a business LOC
A business line of credit can be helpful if you might need money for working capital and emergency expenses. You may also want to use an LOC to finance projects that require progress payments, such as a marketing campaign or new construction.
An LOC may have a lower interest rate and higher credit limit than business credit cards, which can make it a better option for some short- to medium-term loans. However, for day-to-day expenses, a business credit card might be a better option, because you can earn rewards and won’t pay interest if you pay your bill in full each month.
Before opening a business LOC, review the account’s fees and terms closely. Although you’ll only pay interest on the money you borrow, some lenders impose monthly or annual fees to keep your account open. Additionally, you could have to pay a draw fee on each loan you take or an inactivity fee if you don’t use the credit line. Paying off or closing your account early might even result in prepayment penalties or early termination fees.
It’s also important to remember that your creditor can change your credit limit at any time. You might want to use your business LOC during an emergency. But if there’s a widespread emergency, lenders might pull back on credit to help protect their business as well.
Business lines of credit FAQ
Is it hard to qualify for a business line of credit?
You might qualify for a business line of credit if your business is at least six months old and you meet the minimum requirements. However, the account may have a high interest rate and low credit limit. Being in business longer and having good credit and a high income can help you qualify for favorable terms.
How long do you have to be in business to get a line of credit?
You generally need a history of at least six months in business before you can qualify for a business line of credit, but some lenders may require an operating record of one or two years.
How do you get a line of credit for an LLC?
You can apply for a line of credit using your limited liability company’s (LLC) information, including the articles of organization, employer identification number (EIN), and operating agreement. You may need to share information about all of the LLC’s owners.
Is a business line of credit the same as a loan?
In many ways, yes. A business line of credit is a type of credit account, and you can take out loans against your LOC. But the LOC is more flexible than a business loan because you can choose when and how much to borrow and will only pay interest on that amount.
Does a business line of credit show on a credit report?
A business line of credit might appear in your personal credit report if you’re personally responsible for the debt and the lender reports the account to the credit bureaus. Lenders may additionally or alternatively report the account to the business credit bureaus, and it could then appear in your business’s credit reports.