Capital is the foundation for any business. Some companies can tap into cash flow to manage business expenses, but it may be necessary to use business financing for some investments. Many businesses use traditional loans and credit cards to smooth out cash flow and keep operations afloat. In some instances, the extra capital is also used to capitalize on business opportunities that foster growth. But these aren’t the only two ways to inject capital into your business. A business line of credit is another viable option that can provide cash on an as-needed basis. It can be a great fit for business owners who don’t want to commit to a loan or want more flexibility with how they repay debt.
What Is A Business Line Of Credit and How Does It Work?
A small business line of credit is a form of financing that works like a credit card. Upon approval, you’ll get access to a revolving line of credit that can be used as needed up to the credit limit.
Each time you make a payment, the funds become available for withdrawal (except for any amount you pay towards interest). And unlike small business loans, you’ll only pay interest on the amount you draw.
Business owners can embrace a cycle of using a business line of credit, paying it back in full, and then reusing the credit line. Business owners would have to apply for an additional loan if they used up the capital from their first loan and paid it back. Fewer loan applications mean greater access to capital and fewer origination fees.
Most lines of credit have variable interest rates. A fluctuating interest rate creates less consistency with monthly payments, but it’s possible to find a small business line of credit with a fixed rate. A fixed interest rate makes monthly payments more predictable.
Secured vs. Unsecured Lines of Credit
Small business owners seeking credit lines can use a secured line of credit or an unsecured one. A secured credit line gives business owners the opportunity to build credit and qualify for an unsecured credit line in the future. Some secured credit lines use a security deposit that becomes the credit limit. Making on-time payments improves your score and can help people with low personal credit scores or no business credit history establish good standing. You can also take out a secured business credit card, which fulfills the same purpose.
You can also use collateral to secure a line of credit. If you take out a line of credit against a commercial property, that asset becomes collateral. Some lenders let you pledge inventory, equipment, and other business assets as collateral for a small business line of credit.
An unsecured line of credit does not have any collateral or security deposit. These funding sources are usually reserved for small business owners with good credit scores. Unsecured lines of credit usually have higher interest rates, but a good or great credit score can help you secure a lower interest rate from your unsecured business credit line.
You can also choose between secured and unsecured business credit cards. While unsecured business credit cards may have better rewards programs, credit card companies usually charge higher interest rates and set lower credit limits. You can borrow more money if you borrow an unsecured line of credit that is not tied to a credit card.
How Long To Get Approved for a Business Line of Credit?
The time it takes to go from submitting an application to receiving capital for your business depends on the lender. Some approve applications within one or two business days. Others take several days or months to reach a lending decision. Online lenders generally have faster application processing times than traditional banks and credit unions.
Small business owners should consider how soon they need funds before applying for a business line of credit. While the U.S. Small Business Administration (SBA) offers some of the most competitive rates for their small business financial products, it can take well over a month to receive funds. That’s a stark contrast to online lenders that can deliver capital much faster.
How to Get a Business Line of Credit Step-by-Step
Wondering what it takes to get a business line of credit? The process boils down to a few key steps.
1. Decide How Much Funding You Need
Before you reach out to any lender, determine how you will use the funds and how much you need. If you do not request enough funds, you will have to apply for another loan, which means more fees. Realizing you do not have enough funds at a critical moment can tempt business owners to seek fast loans that have higher interest rates. However, if you ask for too much capital, you will pay additional fees and interest that you could have avoided. Asking for more money will ensure higher closing costs for your loan, so it’s a good idea to find your sweet spot.
2. Check Your Eligibility
Most lenders run a hard credit check if you apply for a loan. Hard credit checks reduce your credit score by a few points. They’re not the worst thing that can happen to your credit score, but if hard credit inquiries add up, they can have a more meaningful impact on your score. While the prequalification process may only require a soft credit pull, which will not change your score, applying for too many loans can make it more difficult to qualify for future loans. That’s why it is important to check your eligibility before assembling the necessary paperwork and applying for a loan.
Lenders typically have their own set of guidelines. However, most will evaluate the following:
- Credit history: Lenders look at your credit history to assess if you can manage monthly payments. It gives lenders insights into how you have handled financial obligations in the past. You will need a credit score of around 600 or higher to qualify for a business line of credit. Be mindful that applicants with lower credit scores typically get higher interest rates or are required to put up collateral to lessen the risk of default. Some lenders let you use a personal credit score, but others may require a business credit score to obtain a loan. Getting a business loan gives you the opportunity to improve your business credit, which can help you get more credit limits in the future.
- Business revenue: Your credit score isn’t the only indicator lenders use to assess if you can repay a small business loan. Lenders will look at your revenue during the application process to assess your debt service coverage ratio. Many lenders have DSCR requirements for their loans. An excellent credit score won’t be enough if you have a high DSCR. Business owners can take out loans with more years on them to minimize their monthly payments. A lower monthly payment for your business loan will lower your DSCR and improve your chances of getting approved. If your revenue is relatively high and you have good or excellent credit, you’ll typically get access to a generous business line of credit with favorable terms.
- Time in business: A business owner learns a lot with more years of experience. These individuals learn how to navigate economic cycles, changes to consumer demand, and other business challenges. They get a better understanding of what works and doesn’t work. The average person with 10 years of business experience knows more than the average person who is just getting started, and lenders know this. In most instances, you’ll need at least a year in business to qualify for a business line of credit. Business owners with more experience get more financing opportunities and may even secure lower interest rates due to their time in the industry. Some online lenders will approve your application even if you have been in business for less than a year.
3. Research and Compare Lenders
Before you begin researching lenders, it’s best to understand the differences between short-term and long-term business lines of credit:
- Short-term line of credit: offers a repayment period of up to one year and usually has less stringent qualification criteria, a streamlined application and faster funding times
- Long-term line of credit: offers an extended repayment period with a lower interest rate
Next, you can commence your search for lenders who offer business lines of credit. They’re available through banks, credit unions, online lenders and the Small Business Administration (SBA). You should always shop around for lenders, even if you have been using the same bank for years. Business owners may find lower rates, better terms, or more flexible requirements by expanding their horizons.
4. Check Costs and Fees
Loan fees can significantly increase the balance or present a barrier to entry if you prefer to pay these fees upfront. Once you narrow down your list of lenders, evaluate how much it will cost to go through the loan application process. Common costs and fees include the following:
- Origination Fee/Application Fees: a fee that’s assessed to process your application for a business line of credit
- Service or Processing Fees: a fee you pay the lender to maintain your business line of credit and keep it active
- Prepayment Fees: a fee the lender charges if you pay the amount you draw off early
- Late Payment Fees: a fee you’ll pay if you remit payment after the due date
- Closing Costs: costs you’ll pay to finalize the business line of credit before funding
- Draw Fees: a fee you pay each time you make a withdrawal from your business line of credit
- Insufficient Fund Costs: a fee the lender assesses if your bank rejects a loan payment because you have insufficient funds in your account to cover it
Remember that fee schedules vary by lender – some lenders charge more fees than others.
5. Prepare Application Documents
Lenders will require a few documents that verify your identity and outline your company’s financial health. So before you formally apply for a business line of credit with your top lender, gather these documents to help the process go smoothly:
- Personal and Business Tax Returns for the past three years
- Business Licenses
- Articles Of Incorporation
- Personal and Business Bank Statements for the past year (note: many online lenders only require statements from the past three months)
- Profit and Loss Statements
- Financial Statements
- Business Plan
- Building Lease
Gathering these documents for a lender forces you to have them organized at that moment. When you finish doing business with a lender, store these documents together in a place that is easy to remember. This strategy will help you refer back to these documents if you need to take out another loan.
6. Submit Your Application
Finally, the most important step is to submit a formal application. When completing the form, confirm that all the entries are entered correctly. Otherwise, you risk having your application denied or experiencing processing delays. Beyond the supplemental documents listed above, the lender will also request this information:
- Your Name
- Business Name
- Social Security Number (SSN)
- Desired LoanAmount
- Loan Purpose
- BusinessTax ID
- Annual Revenue
After you submit your application, it’s a matter of waiting for the lender to get back to you. Some lenders may request additional information, but others may state that your application was approved and deposit funds into your account shortly after.
