A small business line of credit (LOC) allows you to draw against a predetermined credit limit, as you need it, instead of receiving the full loan amount at one time like a term loan. The biggest advantage of a business credit line is that you only pay interest on the funds you draw.
How a Small Business Line of Credit Works
A business line of credit is a type of short-term loan that you can draw against as you need it. It’s typically used for short-term working capital to help improve cash flow or to finance the costs of unexpected expenses. It also lets you borrow funds again after repaying a draw, which means it’s readily available to fund your cash flow needs.
These credit lines are similar to a credit card where the line is open and available for you to use, and you only pay interest on the part of the line you draw. It’s a great way to get access to cash that you can put into your business on a moment’s notice.
Unlike a short-term business loan, as you pay down the balance on your line of credit, you increase the amount available to draw in the future. Once a credit line is established, drawing funds from it is usually the fastest way for your business to access capital for quick payments or unexpected events.
Business Line of Credit vs Business Term Loan
A term loan is a lump sum of money you pay interest on until the entire amount is repaid, and it’s typically fully amortized. Term loans are typically used for a specific purpose, like to fund a large piece of equipment. In contrast, unsecured business lines of credit allow you to access the funds as many times as you need once repaid and is best for short-term funding needs.
Business term loans are best if you need one-time funding for a large purchase or other expenses. Keep in mind, you’ll need to reapply for a business term loan every time you need to get financing. This means going through underwriting, paying origination fees, and paying closing costs every single time you need more money.
If you have a constant financing need, then getting a line of credit will give you more flexibility and could save you money. This is especially true if you’re not going to immediately use your full line, as you only pay interest on the outstanding balance. Plus, an open LOC account can be a great way for you to build your business credit. Line of credit products are typically the best solution for short term needs.
Lines of Credit Are Common Among Small Businesses
Since a small business line of credit can be such an affordable and convenient source of capital, it has become a common tool for small business owners. In fact, according to a survey by the NFIB on business cash flow, more than half of all small business owners currently have a business line of credit.
How Small Business Owners Use Credit
Not only do 56% of small businesses have an open line of credit, but 15% of small businesses are relying on borrowed funds as a primary funding source. And this might be significantly underestimating the degree to which small businesses rely on short-term borrowing.
For example, according to Mercatus, 20% of small businesses rely on trade credit (credit given to them by their partners or suppliers, like net-30 payment terms). With these figures in mind, it becomes clear how essential a line of credit might be to regular small business operations.
Where to Get a Small Business Line of Credit
A small business line of credit can be obtained from traditional lenders, like a national bank or regional credit union, or you can get funded through online lenders. When searching for the right provider for your small business, it’s important to know what your goals are for the line of credit.
The four factors you should consider when determining what type of business line of credit lender you need are:
What Business Line of Credit Amount Is Required
Credit lines typically have smaller borrowing limits than term loans, which makes them ideal for unexpected charges but not for large capital investments. If you’re looking for more than $100,000 in funding, then you’ll want to consider a traditional bank. Anything less than $100,000 makes you a good fit for an online lender.
How Soon the Funds Are Needed
If you need initial access to funds quickly upon applying, then you’ll want to look at an online lender that can get you funded in as quick as one day. Short-term loans are generally quicker to obtain from scratch, but drawing from an established line of credit is even faster. Once you’re approved, you can typically access your funds at any time.
If the Minimum Qualification Requirements Are Met
Traditional banks have high minimum qualifications and often require specific collateral. Online providers like OnDeck can be far more flexible. In fact, they often don’t require specific collateral and can approve companies once they’ve been in business for at least one year.
If the Costs Fit Your Budget
Banks offer more affordable credit lines than online providers, but when used for high-ROI opportunities, online small business lines of credit can also be a great option. Additionally, if your bank is offering you a longer repayment term on your credit line, then it could end up costing you more than the short-term online lenders that are paid back in six or 12 months.
In general, only the best borrowers with the most established small businesses will be able to get a business line from a traditional lender like a bank. The faster, more readily available lines of credit are issued by a growing number of online lenders.
What to Use a Small Business Line of Credit For
Ideally, a business line of credit is used for short-term working capital, unexpected costs, unique purchasing opportunities, or to offer credit to your customers. It’s not intended to be used to make big capital purchases like real estate or heavy machinery, or as a way to afford normal operating expenses on a regular basis.
The four main things a business line of credit is typically used for are:
Short-term Working Capital
LOCs are often used to get working capital to make payroll or to cover expenses when seasonal business is slow, or while waiting for customers to pay you. For example, if you are a fashion designer and sell clothes to retail shops, the shops may take a few months to pay you for your work but your bills might be due before then.
Safety Net For Unexpected Costs
Some businesses open a line of credit before they need any cash and then use it for unexpected expenses when they come up. For instance, if a refrigerator at your restaurant needs an emergency repair, a business line of credit would come in handy to finance a quick fix to the problem.
Taking Advantage of Unique Purchasing Opportunities
A business’s wholesaler may have a one-time deal for goods the business purchases frequently, or a wholesaler may have a special sale because it’s going out of business. Having credit to buy in bulk when these opportunities appear can save your business money in the long term. As your overall cost of goods decreases your profit margins will be larger, potentially offsetting the cost of borrowing.
More Confidently Offer Trade Credit to Customers
Giving your customers credit does not come without risk. According to recent studies, 81% of businesses have invoices in accounts receivable that are 30 days past due or more. With a small business line of credit, you can be more confident in offering trade credit because you know you have a safety net available if a client is slow to pay.
The further you get away from using your small business line of credit for the above uses, the more likely it is that you’re using a less than optimal financial product. And this is probably costing your business money.
A short-term loan might be a good fit for you under these other circumstances. If you need up to $500,000 upfront or up to three years for repayment, then OnDeck’s term loan might work for you in addition to its business line of credit. The qualifications and terms are similar, and it can still get you funded within one business day.
Small Business Line of Credit: Banks vs Online Lenders
You typically have two options when you’re looking for a lender to fund your business line of credit. You can get funded through a traditional bank that will likely give you the most affordable terms, or you can get funded through an online lender that is much quicker and easier to qualify with.
Most lenders will base their lending decision on credit score, time in business, annual revenue, and the availability of collateral. Even so, the exact qualifications you must meet, and the terms that accompany a line of credit will vary widely. The biggest differences are in how banks and online lenders vary in their approach to approving small business line of credit products.
Business Line of Credit Qualifications
You’re going to need to be a prime borrower to get approved for a business line of credit from a traditional bank. Online lenders aren’t as strict in their qualification requirements, and often can get you funded with less revenue or time in business than traditional banks.
The qualifications for a business line of credit from traditional banks and online lenders are:
|Time in Business|
|Annual Revenue Required|
|Credit Line Amounts|
Business Lines of Credit with Banks
A business line of credit from a traditional bank can get you funded for $100,000 or more in a few weeks. You’ll typically need to have at least $10,000 in monthly revenue and be in business for at least two years to qualify. Your personal credit score will also need to be good (at least 680) when you apply.
Even those small businesses that meet high qualifications for a top-tier business line of credit at a bank might find it difficult to get funded unless they bring other business or accounts with them. Credit lines are less predictably profitable (compared to a term loan, for example), which means banks can be reluctant to offer them as a stand-alone product.
Lenders that participate in the SBA 7(a) loan program may also offer SBA CAPLines, which have limits of $5 million but have high qualification requirements.
Traditional Bank Business Line of Credit Qualifications
Qualifying for a top tier business line of credit at a bank or through the SBA’s CAPLines program will typically mean demonstrating to a lender that you have:
- Credit score: At least 680
- Time in business: At least two years
- Annual revenue: At least $10,000 per month, trending upward
- Collateral: May be required to pledge short-term or hard assets
- Additional requirements: Your business must be profitable and have no recent bankruptcies, foreclosures, or tax liens
Traditional Bank Business Line of Credit Amounts
Traditional banks often have business credit lines with limits from $10,000 to more than $100,000. Lenders that offer higher limits on a line of credit, reserve them for only the best borrowers and need to be backed by significant collateral.
Traditional Bank Business Line of Credit Interest Rates
Traditional lenders typically offer the most competitive interest rates, somewhere around 9% to 25%. They’ll also offer longer repayment terms than online lenders. This is a double-edged sword. While the monthly costs are likely to be lower, the total cost of capital could end up being higher with a traditional bank if you’re in repayment for a significant amount of time (three to five years).
Traditional Bank Business Line of Credit Collateral Requirements
The reason banks are willing to provide larger lines of credit at lower interest rates is that bank LOCs are typically secured by specific collateral. A line of credit can be secured by real estate, equipment, or other business assets. Some banks let you use your business savings or checking account as collateral as long as you maintain a certain amount of funds in that account.
Banks typically will not want to take a second position on any of your collateral. Generally, the bank will want you to refinance any outstanding loans you currently have through a new term loan with it.
For example, if you currently have a $5,000 equipment loan then a bank will not want to move forward with a LOC until you have refinanced the equipment loan through a new term loan. This allows the bank to have the first position UCC lien on 100% of your assets, which is important to most traditional lenders.
Traditional Bank Business Line of Credit Repayment Terms
Banks offer the best repayment terms if you qualify. Many banks offer one to five years to repay the money you borrow. Most banks offer the option of interest-only payments, instead of a fixed principal and interest payments like a term loan. However, most lines of credit have a clean-up requirement, requiring the borrower to repay the entire line of credit once a year.
How to Apply for a Business Line of Credit With a Traditional Bank
The application process with a traditional lender can be lengthy. Most still have pretty old-school underwriting procedures and a relatively risk-averse culture. Getting approved for a small business LOC with a traditional lender can take weeks, and many trips to the bank.
Establishing a business line of credit with a bank can be limiting in some ways. It can have an impact on your ability to work with multiple financing partners both now and in the future. If you want a quick line of credit to meet your needs, then you may not be up for the process, requirements, and restrictions that a business line of credit from a bank comes with, even if it is more affordable.
Business Lines of Credit With Online Lenders
With small business lines of credit from traditional banks difficult to come by, it’s fortunate that so many online lenders like OnDeck have stepped in to meet the demand. These alternative lines of credit are typically more expensive, but they might be a good fit for a borrower that can’t meet the bank’s qualifications or one that wants more flexibility.
Online Lender Business Line of Credit Qualifications
To qualify for a commercial line of credit from an alternative online lender, you’ll typically need to show that you have:
- Credit score: At least 600
- Time in business: At least one year
- Annual revenue: At least $100,000
- Collateral: Blanket UCC filing and personal guarantee required
- Additional requirements: No recent bankruptcies, foreclosures, or tax liens
Online Lender Business Line of Credit Amount
Most alternative lenders will start qualified borrowers out on conservative credit lines, meaning they might set a lower limit or have a higher-frequency repayment schedule. As the lender becomes more familiar and comfortable with your payment history, you will likely be able to get a higher limit and a longer repayment schedule.
Online Lender Business Line of Credit Interest Rates
The cost of a line of credit from an online lender typically ranges from 30% to 50%. This is slightly higher than what you pay with a small business credit card, but with a business line of credit, you get access to cash you can put in the bank. This is an advantage because you can use it to make unexpected payments that require cash.
Online Lender Business Line of Credit Collateral Requirements
Alternative lenders typically don’t require specific collateral for a line of credit, but they usually do place a blanket lien on business assets. This can make it hard to get additional loans or credit lines while you’re paying off existing ones unless you’re willing to refinance and consolidate the debt. Traditional lenders may also place a lien on your assets, in addition to pledged collateral.
Online Lender Business Line of Credit Repayment Terms
Online lenders are going to offer repayment terms that are shorter than you can get from a bank, in most cases. Many online lenders only allow you six or 12 months to repay the balance of your business line of credit. However, this time restarts every time you draw on the line.
How to Apply for a Business Line of Credit With an Online Lender
Online lenders have leveraged new technologies to provide small business LOCs faster and with less paperwork. While some have the ability to provide credit limits as high as $500,000, most of the credit lines range from $5,000 to $100,000. Qualified applicants are usually funded in a few days.
When to Apply for a Small Business Line of Credit
The best times to apply for a line of credit are when your credit score is high, revenues are increasing, your business hit a big milestone, or before you need the capital. Applying for a line of credit at the right time can position you to be approved for a larger limit, low interest rate, and more comfortable repayment schedule.
Generally, it’s a good idea to apply for a business line of credit if your situation matches one of these four scenarios:
When Your Credit Score Is Strong
Check your credit and make sure it’s looking as good as it can be. If something is being misreported, dispute it and apply for the line of credit once the dispute is resolved. If you need to pay down some revolving debt to improve your score, do so.
While Revenues Are Trending Up
You want a lender to see why it should lend you money, not why you need a loan. Putting your best foot forward means applying for a line of credit when revenues are up and you aren’t desperate for financing. Since you’re not paying interest until you draw on the line of credit, applying for the line before the funds are needed is a no-brainer.
When You Hit a Key Business Milestone
Lenders set benchmarks for credit scores, gross revenues, and time in business. If you hit a new benchmark, like making it to the two-year mark as a business or boosting your credit score by 50 points after paying off some old bills, consider requesting an upgrade to your existing business line of credit or shopping around with some next tier lenders.
In Advance of an Upcoming Capital Need
By planning for your expenses, you can apply for a line of credit in anticipation of a cash flow shortfall. This can help improve your chances of receiving funding because your business isn’t facing an immediate issue. It also grants you the flexibility to draw on the line of credit quickly when it’s needed, rather than applying and worrying whether you will be approved in time.
How to Qualify for a Business Line of Credit
Many lenders focus on five key things when qualifying a business for a line of credit which includes the personal credit score of the owner and the amount of time a business has been operating. They also consider the trend of business revenues, if they have any short-term or hard assets to offer as collateral. Better qualified applicants receive quicker funding, for larger amounts, with lower rates and longer repayment terms.
Lenders who offer a business line of credit typically base their lending decision on five factors:
- Credit score: At least 600
- Time in business: At least one year
- Recent revenues: Minimum trailing at least three months
- Short-term assets: Accounts receivable or assignable contracts
- Hard assets: Real estate, machinery, or equipment
Many lenders will advertise low minimum qualification thresholds. In our experience, borrowers who only meet these advertised minimum requirements are unlikely to be approved for a small business line of credit. This article focuses on minimums more likely to see approval.
Better qualified businesses will qualify for larger credit line limits, lower interest rates, and more generous repayment schedules. Lesser qualified borrowers may be required to make weekly or daily payments on their line of credit rather than monthly payments.
Important Tips About Business Lines of Credit
When planning how to use your line of credit, there are some important tips to get you going. Your line of credit will often appear on your business credit report and your credit limit can be reduced or canceled by your lender in the event of certain circumstances, such as missing payments or a decline in business revenue. Plan around this by using your line of credit responsibly and remembering it’s meant to fill short-term funding needs.
Some important tips when considering how to use your business line of credit are they:
Appear on Business Credit Reports
Lenders will report your business line of credit on your business credit report. This is important when you are deciding what size of a line you need.
Can Be Reduced or Cancelled
It is within a lender’s right to cut off access to a line of credit if the borrower misses payments or if there is a significant decline in business revenue. This is important to keep in mind if you’re a business that runs on tight cash flow. You’ll want to be wary of how much of your credit line you use at any given time.
Barbara Griffith of Southern California Leasing says that most lenders require businesses to provide a financial statement before each renewal (normally once every six months to one year) to maintain the line. “If the financial statements do not qualify for the line of credit,” Griffith says, “the lender can call the line due for payment” or reduce the credit line. Calling the line due means that you must pay back outstanding balances on demand or within no more than 30 to 90 days.
This can be tough on small businesses, which are usually not in a position to pay back a large sum of money quickly. If you find yourself in this position, it is important to talk to the lender about your options. You may be able to provide documentation proving that any decline in business revenue is temporary.
Alternatively, you may be able to find another lender willing to refinance the debt with a working capital term loan. While this won’t be a revolving line of credit, the longer repayment term will typically result in lower monthly payments and ease your business’s temporary cash flow issues.
Pros & Cons of a Business Line of Credit
With a business line of credit, your business can enjoy on-demand funding, while only paying interest on the funds you use. You also won’t have to apply for funding every time you need credit. However, credit limits are often smaller than a term loan and your limit can be reduced or canceled altogether by your lender.
Pros of a Business Line of Credit
The benefits of a business line of credit are:
- Draw funds whenever needed: With a business line of credit, you can draw funds whenever your business has unexpected expenses or cash flow shortages. This offers a great deal of flexibility and means that you can apply and receive a line of credit before you need one.
- Pay interest only on the funds you use: By borrowing exactly as much as you need, your interest costs will be much more manageable. This gives you the flexibility to plan around expenses or seasonality while accurately estimating your financing costs for those events.
- No need to reapply for more funding: By repaying the draw on your line of credit, your credit limit will be restored and you can use the funds repeatedly without reapplying for financing. This saves you precious time and can improve your credit score by avoiding additional inquiries.
Cons of a Business Line of Credit
The drawbacks of a business line of credit are:
- Typically fund smaller amount than term loans: Because a line of credit is revolving, lenders typically offer smaller funding amounts for it than they would for a term loan. This means that if you need a larger amount of funding, all at once, a line of credit may not be the best option.
- Not a good solution to long-term working capital problems: A line of credit is a great option for managing any short-term cash flow issues. However, it can do more harm than good if your cash flow issues are chronic and long term. By adding interest payments to your cash flow shortages you could potentially find yourself unable to make payments.
- Credit limit can be reduced or canceled by the provider: Your lender often reserves the right to reduce your credit limit or cancel the line of credit. This happens if you don’t make timely payments or your business and your creditworthiness is not doing well. However, if things improve, lenders will often increase your credit limit automatically.
What Is a Business Line of Credit: Frequently Asked Questions (FAQs)
What is a business line of credit used for?
A business line of credit is used to finance short-term working capital shortages or as a source of funds for unexpected expenses and opportunities. A business line of credit is revolving allowing you to draw up to your credit limit again after repaying a draw, providing a great deal of flexibility.
Should I get a business loan or line of credit?
A business line of credit often has lower overall costs compared to a business term loan of the same size. It’s also revolving and gives you access to credit without needing to reapply. However, a business term loan can offer more capital all at once and longer repayment terms for larger expenses.
Can you use a business line of credit for personal use?
A business line of credit is meant to be used solely for business purposes. Failing to keep your personal and business funds separate can put your personal assets at risk if your business defaults. You’ll also find that unlike interest on business expenses, interest paid on funds used for personal use is not tax-deductible.
Bottom Line: What Is a Business Line of Credit
A small business line of credit can be an affordable solution for both short-term working capital and emergency financing. However, it requires you to plan your application in advance to get the best rates and terms. Your best line of credit option is through a traditional bank, but its qualifications are tough to meet. It’s easier to qualify with online lenders, and you’ll get funded much quicker.