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10 things to understand about business line of credit

a business line of credit, At one point or another, everyone borrows money. That’s no exaggeration, either. You borrow money to buy a car. Your parents borrowed money to buy a house. Banks borrow money. Even the federal government borrows money. Borrowing is just a fact of life, meaning that one day; your small business will probably borrow money, too. But as long as you understand and use it the right way, borrowing can be an incredible resource for your business.

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When you need to manage cash flow, buy inventory or pay for an unexpected expense, then a business line of credit makes sense.

business lines of credit

A common unwritten business rule is that it’s better to have access to financing before you need it. If you wait until your business is in a desperate financial situation to apply for a loan, you may not get the funding you need in time. That’s why taking out a line of credit could be a smart move for your businesses. However, before jumping at this type of financing, it is important to understand the pros and cons so you can decide whether this financing option is right for you.

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What Is a Business Line of Credit?

A business line of credit gives you access to a predetermined amount of money that you can borrow from on an as-needed basis. Instead of receiving an upfront lump sum, you have access to a revolving line of credit. A business line of credit is ideal for short-term operating expenses, like payroll or inventory.

A business line of credit is far more flexible. The bank gives you a limit, let’s say it’s $10,000, and you’re free to borrow however much you want as long as you stay under that limit. The great reason is you’re only paying interest on what you use. Let’s say you take out a business line of credit and only borrow $1,000. That’s way under your $10,000 max. With a business line of credit, the juice is only running on the $1,000 you’ve borrowed. It’s fair, intuitive, and manageable. Some people call these “revolving lines of credit,” because once you hit your max, your dynamic with the lender isn’t “over.” All you have to do is pay off some of the balance, which frees up some of your credit lines — and boom — you can start borrowing again.

So, when you think of a business line of credit, think of flexibility. A business line of credit gives you the flexibility to manage the amount of interest you’re paying. If you’re flush with cash for one month, you can just pay off your entire balance. Then, once you have a balance of zero, you’re not paying any interest at all. This is in contrast to a loan, where you’re locked into paying interest on that entire lump sum for the entire term of the loan.

How does a business line of credit work?

A line of credit works similarly to a credit card. With a line of credit, you can draw funds as needed and repay them over time. You can keep reusing and repaying your line of credit as often as you’d like, as long as you make payments on time and don’t exceed your credit limit.

You pay interest only on the portion of the money that you borrow, and most lenders allow you to repay your full balance early to save on interest costs.

A business Line of credit borrowing limits ranges from $1,000 to $250,000 and are usually smaller than term loans.

How to get a business line of credit

At a minimum, you’ll need at least six months in business and $25,000 in annual revenue to qualify for a business line of credit. Although not all lenders set a minimum credit score, borrowers most likely will need a score of 500 or higher to qualify.

Business lines of credit are issued by traditional lenders, like banks, as well as online lenders like OnDeck and BlueVine. Interest rates and borrowing limits can vary widely depending on the lender’s requirements and the borrower’s circumstances.

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When you apply for a business line of credit, lenders typically require documentation including personal and business tax returns, bank account information, and business financial statements, such as profit-and-loss statements and a balance sheet.

Most traditional lenders require businesses to have strong revenue and several years of history to qualify for a line of credit. Larger lines of credit may require collateral, which can be seized by the lender if you fail to make payments. SBA lines of credit have similarly strict requirements.

Online lenders typically have lower qualification requirements than banks. However, these lenders are also likely to charge higher rates than banks and may have lower credit limits.

After approval, lenders may be able to issue business lines of credit in a matter of days. Banks generally take longer than online lenders to set up new lines of credit.

Secured vs. Unsecured Business Line of Credit

The line of credit you receive will either be a secured or unsecured loan. A secured line of credit requires some type of collateral. For instance, you could use property or equipment to secure the line of credit. Banks and credit unions commonly give out secured lines of credit. This collateral gives the bank more security because, if you default on the line of credit, it can collect on the collateral.

business lines of credit

An unsecured line of credit doesn’t require any collateral. This is ideal for most business owners because you’re not putting your business or personal assets at risk.

The Benefits of a Business Line of Credit

You know that old saying, “It takes money to make money?” That’s the importance of a business line of credit. It gives you the money you need to make money. These happen in a bunch of different ways, but let’s take a look at a few different examples.

First, let’s say you are in the restaurant business and have an unexpected spike in demand. You’re in the Christmas season and are selling as fast as you can serve. A line of credit helps you buy more inventory and take full advantage of this spike in demand.

Next, let’s say the restaurant business is so good that you want to expand your team. When you draw on your business line of credit, that puts a corresponding amount of cash in your bank account. You’re then allowed to use that for payroll and can afford to hire another all-star.

Third, let’s say, if it’s past the Christmas season and sales are pretty slow, you can tap your business line of credit to help weather the storm and keep your operation running.

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The Downside of a Business Line of Credit

As you’ve seen, a business line of credit can be your friend financially. But you also want to be aware of a few things. First, you’re going to spend a decent amount on interest, as opposed to financing your business through the cash you already have on hand. So, before you tap your business line of credit, make sure you do a little math and that it justifies those interest payments. Second, if you take out a secured line of credit and can’t pay it back, you lose your collateral. Whether that’s your house, a factory, or a delivery vehicle, always remember that you’re putting this on the line. Third, if you get in over your head, you can ruin your credit. That can make it tough to open lines of credit in the future, which limits your access to all of those benefits you just read about above. So, whenever you borrow money, just remember this isn’t free. You need an actionable plan to pay this back and that plan needs to be realistic. That money sure is nice once you’re approved, but it’s like they often say “You don’t get anything. You have to earn it.” So, make sure you treat this like it’s your money. Because it is.

How to Get Approved for a Business Line of Credit

Lenders look at a bunch of different things but always dial in on a few factors in particular. First, they want to see consistent revenue. If you bring in a steady flow of cash for a few years in a row, they’re more confident you can pay them back. Second, they like to see the documentation. The nature of that can vary, but they’ll usually ask for bank statements and tax returns. So, make sure you have all your ducks in a row.

Third, they’ll look into your credit score. They do this to approve your application, but also to set your interest rates. So, if your credit is in great shape, you might pay way less in interest. If this seems like a lot, don’t worry. You’ve got this.

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Tips for Getting Approved

Put Up Collateral – If you’re having trouble getting approved, ask about secured lines of credit. Offering to guarantee your credit line with one of your assets could be just the thing that helps get that application over the net.

Explore Online Lenders – Banks typically have more stringent requirements. They’re just larger entities with more overhead and protocol.

So, they’re typically more risk-averse. But a few online lenders are aware of this and have stepped in to offer you another option. They might be more comfortable with a higher level of risk for those newer applicants.

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Boost Your Credit Score – Some people are surprised to learn that when you apply for a business line of credit, the lender might also look at your credit score. So, make sure your house is in order on the personal side to give yourself every last advantage.

Verify Your Application Is 100% Accurate – If you’re not sure what something means on the application, just ask. Your life is busy and you’re tracking a ton of information. But you don’t want to wing it, guesstimate, or rely solely on memory. They’re making a huge decision based on the info you’re passing along, so make sure everything is perfect.

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