Many small business owners use financing to purchase equipment, commercial properties, and other assets. Additional capital also makes it easier to address inventory, wages, and other recurring costs. While small business lenders offer many financial products that can help you grow your company, interest rates discourage many people from getting small business loans. You could end up paying a lot of interest even if you don’t use the loan proceeds right away.
If you’re frustrated about paying interest before using your capital, you’ll enjoy using a business line of credit. This is because you only pay interest when you use funds instead of when you take out a loan. We’ll share key details about credit lines, so you know how to get them and if they make sense for your business.
What is a Business Line of Credit?
A business line of credit is a commercial loan product that you can use on an as-needed basis to cover working capital or make purchases. It is a popular financing method for small business owners who need to cover short-term expenses. These cards let you escape the monthly payment cycle of small business loans and give you more flexibility to repay money borrowed against the credit limit.
How Does a Business Line of Credit Work?
A business line of credit is a loan product that behaves like a credit card. However, instead of getting a lump sum of money, you’ll get access to a pool of cash that you can make withdrawals from during what’s referred to as the draw period.
You can make as many withdrawals as needed, up to the limit, and make interest-only payments on this amount. And as you repay what you borrow, the funds are free for use again. Credit lines save you from having to reapply for another business loan after catching up on payments.
While some financial products have fixed-rate loans, business lines of credit use variable rates. Not having a locked rate can create some unpredictability in your business expenses. However, if you quickly repay the balance, the variable rate won’t have much of an impact on your finances.
When the draw period ends, the remaining principal balance is converted to a loan that’s payable in monthly installments over a set period. But if you repay what’s owed before the draw period ends, you won’t owe the lender any interest. So, people use this advantage to cover short-term expenses they can quickly repay when additional revenue arrives in their checking accounts.
How to Get a Business Line of Credit in 4 Steps
Ready to get a small business line of credit or want to understand the process before fully committing? You can follow this 4-step process to get a line of credit for your company.
1. Find Lenders Offering Business Lines of Credit
Traditional banks, credit unions, and online lenders are some of the many entities that offer business lines of credit. While your local bank or credit union may have options, they may have stringent qualification criteria or only extend loans to established businesses.
If you’re just getting started or have experienced a few rough financial patches, an online lender may be the better option, as they’re generally more lenient. In addition, some of these lenders do not have personal credit score requirements, making it easier for people with bad credit history to get financing. Of course, you can get a respectable rate even if you have bad credit, but it’s no secret that a business owner with a good credit history will get better offers.
Another important consideration is the type of business line the lender offers – secured or unsecured. Secured business lines of credit put your assets at risk if you default on the loan. However, you could get an unsecured business line without putting your assets up as collateral. While an unsecured credit line seems like the better choice, it usually comes with a higher interest rate. Lenders will lower their rates if they can offload some of their risks. Good credit and collateral on the loan will make a lender more confident to work with you. A secured line of credit can also be easier to obtain for small business owners with bad credit.
Most business credit cards are unsecured forms of financing. These cards have higher interest rates than most business-term loans, but you’ll get rewards for every purchase. You can get far superior rewards with a business credit card than a personal credit card, but you can only use a business credit card for business-related purchases.
2. Review Lenders’ Requirements
Each lender has its own set of guidelines based on how much risk they want to incur. Reviewing requirements before starting the application process will save you time and preserve your credit score. Since most lenders use hard credit checks to verify your credit history, your score can take a small hit with each loan application. You should only apply for loans you believe you can get, and reviewing these line of credit requirements will help you pick your options wisely.
- Credit score: Most traditional banks prefer a credit score of 680 or higher, but you could qualify with a credit union or online lender if your score is in the mid-500s.
- Company history: It’s best if you’ve been in business for at least six months before applying for a business line. However, traditional banks and credit unions prefer to do business with companies that have been established for at least two years.
- Annual revenue: Many lenders have annual revenue requirements to ensure business owners can afford the monthly payments. These amounts vary by lender, but you’ll have steeper requirements for banks and credit unions.
3. Prepare Documentation Required by Lenders
Lenders review several documents to verify your identity, business, and income. Each lender has different document requests, but you should expect to provide the following resources to any lender:
- Your company’s Federal Employer Identification Number (FEIN)
- The three most recent bank statements on your business checking account
- Your company’s most recent tax return
- Your most recent personal tax return
- Your company’s schedule of debts
- Your company’s articles of incorporation (and other legal documents)
- Current and projected financial statements
- Business licenses and registrations
- Franchise agreements
Ask your preferred lenders what you’ll need before you apply. Due diligence will save plenty of time during the loan application process. You don’t want to get rejected because you forgot to submit a document. Business owners can remediate the issue by providing the right document. Still, if you need quick funding in a few business days, it’s best to include all of the necessary documents the first time.
4. Submit Applications for Business Lines of Credit
Narrow down your list of potential lenders and submit a formal application with your top selection. Be sure to complete the application in its entirety and submit the required documents promptly to prevent accidental rejection or processing delays. Submitting a few applications won’t make a major dent in your credit score, especially if you apply with lenders that don’t conduct hard credit checks.
Know How Much You Need Before Applying for a Business Line of Credit
Getting additional financing can feel exciting. You can use these funds to gain more market share and increase your company’s capabilities. However, some business owners do not consider the optimal amount of capital for their business lines of credit. Not having a high enough credit limit can put you in a challenging situation where you’ll need to raise additional funds. That means more applications, reviewing lenders, and waiting for money to arrive. While this flexibility gives business owners more choices, it’s best to borrow the right amount of money the first time.
Just as you can borrow too little, you may accidentally borrow more than you need. This isn’t as much of a problem for a revolving line of credit since you only pay interest when you borrow against the credit limit. However, taking out too much money becomes more concerning for business loans with monthly payments and interest. Review your business expenses and upcoming investments to determine how much you need from your business line of credit. Having a number in mind will make the loan application process much simpler.
When It Makes Sense to Go with Another Loan
Sometimes a business credit line won’t give you enough funds for your investments. In that case, you can take out an SBA loan instead. These financing products usually provide more capital than business credit lines and help with long-term investments. Even if you opt for a traditional loan, a business line of credit is a useful addition. It’s possible to never use your business credit line or make any payments other than an annual fee if your lender includes that charge in the terms and conditions.
Equipment financing is usually the better choice for business owners looking to purchase equipment. This is because the equipment becomes collateral on the loan, helping you secure a lower interest rate in the process. Of course, you could purchase equipment with a business line of credit, but interest rates will likely be higher unless you quickly pay off the debt.
