Is it a Good Idea to Have a Business Line of Credit?
When cash flow is tight, a business line of credit can be a lifesaver.
The coronavirus pandemic has thrown many small-business owners into an unprecedented financial crisis. Small-enterprise disaster funding, including business lines of credit, has sparked interest due to revenue losses and COVID-19 expenses.
A business line of credit can be highly beneficial to help a business take advantage of an opportunity or weather a crisis. It can allow you to borrow only what you need, up to your credit limit, and only pay interest on the money you have borrowed. It might be one of the best tools available to your business if you can qualify and use the line of credit wisely.
What Is a Line of Credit for a Business?
A business line of credit gives your business a set amount of money that it can utilize for short-term expenses like paying suppliers or meeting payroll. You can borrow as much money as you need up to your limit, and the amount you borrow is considered a loan.
A revolving business credit line allows you to borrow additional money as you repay what you’ve borrowed without having to apply for another line of credit. You can utilize your credit line for as long as your lender allows it if you make at least minimum payments and keep under your credit limit.
Some lines of credit are unsecured, while others are secured by assets that the lender can seize if you don’t pay on time.
Lenders may require weekly or monthly payments, with repayment periods ranging from a few months to several years. Your payments may vary depending on how much you borrow.
Only the amount you borrow is subject to interest. If you have a $100,000 credit line and only use $20,000, the remaining $80,000 will not be charged interest.
Of course, this does not imply that business credit lines are free. You could, for example, pay origination, maintenance, and draw costs as you open and use your account.
By phone, online, or with a debit card or checks from your lender, you can move funds from your credit line to your bank or savings account. However, ATM transactions may result in costs.
You’re right if you believe these lines of credit sound like credit cards. The main distinction between the two is that business lines of credit typically have far higher credit limits than credit cards.
Is a Business Loan or Line of Credit Right for You?
Your circumstances will determine whether a business loan or line of credit is appropriate for you.
Business loans: A business loan is a fantastic option for scheduled needs like equipment financing.
When you take out a loan, you borrow the entire amount at once and pay it back over a period of time.
Business lines of credit are used for short-term business expenses that will be repaid in a few months or years. In uncertain times, such as when revenue and expenses are difficult to estimate, a business line of credit is preferable. However, keep in mind that lines of credit are more likely to have variable interest rates, which means your interest rate could jump if you miss a payment. If you go with an online lender rather than a traditional one, you can end up paying more.
Interest rates with online lenders can be higher than at your local bank or credit union and many of these loans don’t have the benefit of prepayment – meaning that it doesn’t matter if you repay the loan early. Meaning you will have to pay the full amount of the interest.
The advantages of business credit lines with these lenders: Applications are usually fairly straightforward, you get a decision in minutes and funding can happen within 24 hours, she says.
What Are the Requirements for a Business Line of Credit?
Lenders have different requirements for business lines of credit. During the coronavirus outbreak, however, several lenders cut back on business credit lines or tightened credit requirements.
Some stopped offering them temporarily, while others are only offering them to certain customers with the best credit profiles and most stable businesses. They will come back, though, once the crisis is over. And if there’s one thing we’ll have learned is that it’s a good idea to have savings and access to credit before you need it.
What to anticipate now: Most lenders require not just basic information about your business, such as its type, legal structure, and ownership, but also earnings, financial statements, and tax returns. Whether you apply for a business line of credit with a typical bank, a credit union, or an alternative lender will determine the rest of the details.
Bank of America requires at least two years in business under current ownership and $250,000 in yearly revenue to qualify for a secured business line of credit. A credit union will require you to first join by creating a bank account, and then meet the credit union’s specific conditions for a business line of credit. An alternative lender will normally require you to have been in business for at least six months and have a minimum yearly income of $50,000.
The SBA provides a detailed submission checklist if you’re interested in a Small Business Administration CAPLines loan to fulfill short-term or cyclical capital needs. Businesses must meet 7(a) loan program requirements as well as CAPLines loan requirements.
Whatever option you choose, the lender will pull your credit reports to evaluate how you’ve handled credit in the past and to assess your debt load. If you’re comparing rates from various lenders for the same loan, it shouldn’t have much of an impact on your credit score. If you choose an alternative lender, you should be able to find out the status of your application within minutes. Because they probe further into your financials, other lenders may take days or weeks to make a decision.
Your credit ratings may be too low, your firm too new, your loan size too large, or your industry too dangerous, according to Detweiler, if you apply but do not qualify for a line of credit.
What Are Your Options for Obtaining a Business Line of Credit?
From huge commercial banks to local lenders and credit unions, a wide range of financial institutions offer business lines of credit.
If you can qualify for a line of credit through your bank or credit union, that’s likely to be the lowest-cost option. You can also try a credit union or community bank, or even a Community Development Financial Institution.
Online lenders like Idea Financial and BlueVine are another alternative. These alternative lenders may be attractive to businesses with a medium or high credit risk rating that have been in operation for less than five years.
Alternative lenders may be easier to work with than traditional financial institutions, but they may charge you more in interest to compensate for the risk. Even said, some business owners are willing to pay a higher rate in exchange for immediate access to funds.
When John Yung needed funding for his Korean cuisine venture, he turned to Idea Financial for a business line of credit. According to Yung, “We needed additional funds to get us through our equity crowdfunding campaign, therefore the total amount needed had to be over $15,000. While the interest rate was important, it was not the most important factor. The application process was very streamlined and simple and we feel more comfortable knowing we have the funds available immediately for future short-term needs.”
If you go with an online lender, you can usually expect faster decisions than if you go with a traditional bank. Online lenders may verify your credit by looking at activities in your business bank account as well as your personal credit. Online lenders often charge higher costs, though, so you want to make sure you understand the cost and how it will affect your financial situation. You may want to use a line of credit to grow or maintain your business, not to hurt it.
The Small Business Administration, or SBA, partners with banks to offer the CAPLines program, which is another source of business lines of credit. This program’s four services assist small businesses in filling finance gaps.
What Are Business Lines of Credit Interest Rates?
Personal and business credit ratings play a big role in interest rates for business lines of credit.
Your interest rate may be high if your credit rating is low – at least at first. However, if you appropriately use the credit line, the lender may reconsider the terms.
Consider an example of a business line of credit from one of our clients, which has a nearly 19.5% interest rate and a $20,000 cap. After four months of on-time payments, you can refinance the line, lowering the interest rate to around 10% and increasing the credit limit to $35,000.
Most lenders use the five C’s of credit to decide the size of the credit line. These are some of them:
- Capacity, or the ability to repay
- Credit history or character.
- Earnings and savings, or capital.
- What you can put down as collateral to secure the line of credit.
- The loan’s purpose and the economy’s strength are the conditions.
Based on these factors and your demands, your credit limit could range from a few thousand dollars to $500,000.
How Can a Business Line of Credit Be Used?
To satisfy short-term working capital needs, you can use your business line of credit as needed. However, you’ll need to be cautious about how you spend the money.
Before you get a business credit line, make sure you can pay it off quickly. This will enable you to use the line to pay down debt if your business grows and you face financial difficulties. By making payments on time, you’re also building the company’s credit rating, which can allow you to refinance your line of credit at a lower interest rate and for a larger amount.
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