When unexpected expenses or changes in income shake up your budget, a line of credit can provide the funds you need. Perhaps you're planning a project but aren't sure the exact cost, or you know that over the course of this year you'll need several opportunities to withdraw funds. With the right knowledge and a solid financial history, you can apply and qualify for a line of credit before finding yourself without the funds your business needs.
Lines of Credit: The Basics
Similar to a credit card, a line of credit provides a set amount of money you can draw on when you choose to. Most credit lines are revolving, meaning you borrow what you need and only pay interest on the amount you borrow. Personal and business lines of credit are generally unsecured and pose a greater risk to the lender, although business funding is sometimes secured with your equity in the business you are taking the loan for. Talk to your lender if you're looking for a secured line of credit and weigh the pros and cons of unsecured and secured loans.
Payment structures differ between lenders. You may be required to start paying back what you borrow right away, or the credit line may be divided into “draw” and “repayment” periods. In the latter situation, you’re given a set period of time, usually ranging from 5 to 10 years, during which you can draw on your credit limit. During that time, you may make payments on either the interest or both the interest and the principal. After the draw period is over, you’re required to pay back the remainder of the principal using a payment structure determined by your lender.
When to Take Out a Business Line of Credit
There are several situations that make a line of credit a good alternative to other forms of business funding:
- Your personal or business expenses vary widely throughout the year
- You rely on fluctuating income from seasonal work or sales made on commission
- If available interest rates are lower than what you can obtain through credit cards or traditional loans based on your business revenues and credit score
- You require the flexibility to spend on whatever business needs you have. Many business term loans are mandated for specific uses only, such as construction or inventory, whereas lines of credit do not have such restrictions.
Applying for a credit line is similar to applying for any business loan. The lender requires a completed application along with specific types of information, including:
- Income and expenses
- Past and current debts
- Credit history and current credit score
- Payment history
- Personal assets
- Asset valuation if you're using collateral
- Analysis of risk and profitability
When Not to Use a Credit Line
Although there are many situations in which credit lines are helpful, you can get yourself into financial trouble if you draw on your limit for the wrong reasons. It may not be a good idea to use a line of credit to:
- Make a large purchase for pleasure, such as an expensive vacation or a new car
- Pay off expenses you can afford with the cash you have on hand
- Try and dig your business out of other debts
- Make risky investments or financial speculations
In these cases, there are better and cheaper ways to cover payments and handle debt. If you’re having trouble managing your money and you find yourself relying on your line of credit for everything, it may be time to meet with a financial business advisor.
When considering a business line of credit, make sure you understand your financial needs before applying. Know the terminology, get clear information about the fees, and establish a budget plan to ensure you don’t wind up worse off in the long run. You can also read lender reviews, like this one from Kabbage, in order to understand what kind of loans each lender offers and how to qualify.
Credit lines come with fees, interest, and minimum payments to consider. Get all the details about these and any additional requirements before applying, and set up a plan to ensure on-time payments. Aim to keep a zero balance as often as possible, only drawing on the funds when necessary, similar to how you might use a credit card. If you decide to use your credit line after weighing the advantages and drawbacks, borrow only what you need to cover the expenses, and follow your plan to pay back the borrowed amount as soon as possible. When you’re ready, compare business line of credit lenders in order to find affordable terms and rates. Visit these articles to learn how to make the most of your credit line once you’re approved.