What Is a Business Line of Credit & How Does It Work?
Tricia has nearly two decades of experience in commercial and federal government lending. Her expertise is highlighted throughout small business loan content on Fit Small Business.
Andrew has over a decade of experience in finance and mortgage lending. He shares his expertise in Fit Small Business’s financing content.
This article is part of a larger series on Business Financing.
A business line of credit is a loan that lets you draw against a credit limit and deposit it as cash into your bank account. It’s a revolving loan, so as you pay down the balance, you can then draw additional funds you need up to the credit limit. In most cases, monthly payments are required, and the full balance of the loan must be repaid in less than 24 months. You’ll pay interest only on what you use, making it a useful tool for having quick access to cash to cover unexpected expenses.
As an example, if a lender gives you a business line of credit with a credit limit of $100,000, you can choose to draw any amount up to that limit. Drawing $75,000 will give you $75,000 in cash deposited to your bank account, and this must be repaid within the time frame specified by your loan agreement, typically less than 24 months.
Highly rated providers of business lines of credit, such as Bluevine, offer loan amounts up to $250,000 and a quick funding process. For more information or to apply, visit Bluevine’s website.
How a Business Line of Credit Works
Step 1: Choose a lender and submit an application
Pick a lender based on your ability to meet its qualification requirements. You can also consider what it offers and what’s most important to you. This can include customer service, rates offered, fees charged, flexibility of approval criteria, loan amounts offered, and funding speed. Prioritize what you must have in a loan and what you can do without, as it can be difficult to find a lender that does well in each area.
Most lenders have applications that can be completed in less than 5 minutes. You can specify the type and amount of loan you’re seeking and provide basic information about your business. Make sure to get quotes from multiple lenders before choosing one. If you’re unsure where to start, you can check out our list of the best small business lines of credit.
Step 2: Provide documents to the lender
Be prepared to provide the lender with financial statements for yourself and your business. This information is used to confirm that the information on your application is correct, that your business meets the lender’s requirements, and that you have the capacity and ability to repay the loan. Tax returns, bank statements, cash flow statements, and profit and loss (P&L) statements are commonly requested items.
Step 3: Review and accept terms of loan approval
The terms of your approval will depend on your qualifications. Businesses with strong credit and income and those that have been in operation for several years can often qualify for high credit limits and low interest rates. Other important terms of your loan can include prepayment penalties, minimum draw amounts, inactivity fees, annual fees, and repayment periods.
Step 4: Begin using your line of credit and making loan payments
Upon accepting the terms of your loan, your line of credit will be available for use within 24 to 48 hours—and no payments are required until you draw funds. When this is done, funds will be deposited into your bank account and the loan must be repaid within the time frame specified in your loan agreement, typically six to 24 months.
Step 5: Provide lender with documents needed for annual reviews
Many lenders require an annual review of your business to renew your line of credit. This is to ensure you’re still in a position to repay the loan. You may need to provide updated financial documents such as tax returns, cash flow statements, and P&L statements. Based on a review of these documents, your line of credit can be renewed with no changes, terminated, or renewed with different terms, such as a higher rate or reduced credit limit.
Types of Business Lines of Credit
There are different types of small business lines of credit:
- Unsecured business line of credit: This doesn’t require you to pledge any business collateral for the loan. If you default on the loan, your lender won’t have any right to repossess your business assets.
- Secured business line of credit: This requires you to pledge assets as a condition of receiving the loan. If you default, the lender has the right to take possession of your assets to recoup its losses.
Who Should Consider a Business Line of Credit
If you’re a business owner who wants quick access to cash to cover emergencies and can pay off the loan in a short time frame (typically 24 months or less), you should consider a business line of credit. Unlike other types of loans where you receive a lump sum of cash up front, a line of credit allows you to draw funds only when you need:
- You have income that fluctuates throughout the year: Fluctuating income can sometimes make it difficult to cover all monthly expenses. Having a line of credit can help cover temporary cash flow shortages.
- You want the ability to cover unexpected expenses easily: Unexpected expenses such as equipment breaking down can hurt your company’s ability to earn revenue. Many providers offer lines of credit up to $250,000, an amount that should be enough to cover most emergencies.
- You intend on paying off the loan in a short period of time: Interest rates on some business lines of credit can be higher than other types of loans, making it a more expensive form of financing. Additionally, many providers of these lines of credit require you to repay the full amount of your loan within six to 24 months.
- You want the freedom to use cash for any type of business expense: Once you have been issued a business line of credit, you can use it for any type of business need such as payroll, equipment repairs, travel, and more. Other types of loans, such as equipment loans, usually have restrictions on how you can use the funds.
Qualification Requirements for a Business Line of Credit
- Credit scores: Personal credit scores above 650 give you a better chance of landing an approval, although some lenders have lower requirements as low as 600. Higher credit scores show that you consistently make timely payments and are likely to continue that trend. Some lenders may also review your business credit score.
- Business revenue: Minimum revenue requirements can be as high as $180,000 annually or as low as the minimum amount of income you need to afford the monthly loan payments. In some cases, personal income earned separately from the business can improve your odds of landing a loan approval.
- Time in business: Many lenders will require at least six months’ time in business. Lenders know that many businesses fail within their first two years of operating, so making it past that time frame can make it much easier to get approved for a business line of credit.
- Collateral: Pledging collateral allows the lender to repossess your property if you default on the loan. This is often done with a uniform commercial code (UCC) filing, and is required for many secured business lines of credit, but has the potential to provide you with more favorable loan terms since it reduces the lender’s risk.
How To Choose a Business Line of Credit
In choosing a business line of credit, consider the following features and characteristics offered. Lenders may not perform well in all of these areas, so you should prioritize which ones are most important to you:
- Rates: Lower rates save you money on interest charges, but also pay attention to how the rate is calculated. In many cases, the rate is variable and can change over time.
- Fees: Upfront and recurring fees can make a line of credit more expensive than you might think, so you should think about which ones are likely to impact you. Common fees include origination fees, annual fees, inactivity fees, draw fees, and prepayment penalties.
- Repayment term: Most lines of credit must be repaid within six to 24 months after you draw on the line. Payments tend to be higher with a shorter repayment period, so you should make sure you can afford to make the minimum required payments.
- Loan amount offered: In most cases, business lines of credit up to $250,000 can be obtained. Make sure that the amount you get is enough to cover the purchases you might need to make.
- Qualification requirements: In addition to making sure you meet a lender’s requirements to initially qualify for a line of credit, you should also think about your chances of being able to meet any annual renewal requirements. Many lenders require an annual review of your business line of credit to see how your business finances have changed and whether you still have the ability to repay the loan.
- Customer service: Check reviews to see how others have rated the lender’s level of service. The company should have long hours of operation, make it easy to reach a live person, and have knowledgeable team members.
Pros & Cons of a Business Line of Credit
| PROS | CONS |
|---|---|
| Quick access to cash | Many charge an annual fee, even if you never use the line of credit |
| Flexibility to draw funds on an as-needed basis | Less ideal for long-term financing due to higher rates and shorter repayment periods |
| Payments are calculated based only on what you draw | Many lenders require an annual review, which can result in termination or reduction of your credit limit |
| Generally no restrictions on what you can use the loan for | Typically has a variable interest rate |
Alternatives to a Business Line of Credit
A business line may not be the cheapest option for quick access to cash. Here are some other loans that could save you money in interest charges:
- Small business credit cards: These are similar to an unsecured line of credit but give you the ability to make purchases directly with the card. Lenders frequently offer low introductory or promotional rates as low as 0%.
- Credit card stacking: This is a method of applying for multiple credit cards simultaneously. The combined credit limits on the cards can give you more purchasing power than you would otherwise have on just a single credit card.
- Small business loans: You can get a small business loan for a specific purpose at more competitive rates than a line of credit. Some examples include equipment loans, working capital loans, and startup loans.
Bottom Line
A business line of credit can give business owners quick access to cash to cover emergencies and temporary shortages of cash. However, repayment periods aren’t as long as other types of loans, so it’s usually best to use a line of credit for short-term expenses that you can repay within 24 months. Shop multiple lenders before choosing one, and consider other types of loans that might save you money while still meeting your funding needs.
