Similar to a personal line of credit that leverages the equity in your home to provide extra cash for home improvements or other household needs, a business line of credit is a revolving credit line that gives business owners access to a fixed amount of money they can use to meet short-term capital needs. A line of credit is a great way to access cash for things like:
- Purchasing inventory
- Repairing equipment
- Financing a marketing campaign
- Overcoming a short-term capital hiccup
- Ramping up for a new contract
Unlike a term loan, a line of credit makes capital available to withdraw as needed, instead of in a lump sum. And, you only pay interest on the amount of the credit line you actually use—which makes a line of credit a good choice for many small business owners who have seasonal or predictable short-term cash flow needs. They can access the line of credit when needed, pay down the balance, and use the line again.
How does a Business Line of Credit Work?
There are two types of credit lines offered by lenders to business owners:
- A secured business line of credit: As the name implies, a secured business credit line requires an asset (or assets) be pledged as collateral. If the borrower is unable to make the payments on any capital borrowed through the credit line, the lender will assume ownership of the collateral to pay off the balance.
- An unsecured business line of credit: An unsecured line of credit typically doesn’t have any specified asset identified as collateral, but will often include a general lien on business assets to secure any funds accessed through the credit line.
Both secured and unsecured lines of credit are available from banks and online lenders.
When you open a business line of credit, you receive access to a stated amount of funds to use as needed. You’ll receive a regular statement detailing the amount of credit you’ve used, your interest charges, your balance, and the remaining amount of credit you have available (many online lenders make this information available online, so you can see this information anytime you’d like 24/7).
Because a business owner is able to access funds as needed and only pays interest on the amount of capital he or she borrows, a line of credit might be considered a more flexible way to access short-term capital than a term loan. Payments are based upon the amount accessed and the interest accrued by those funds as you use them. Once the funds are repaid, that amount is available to use again when you need it.
Many lenders also charge some kind of annual fee for their credit lines in addition to interest charges, so make sure you understand what those charges are when you apply. Smaller credit lines (under $100,000) can work much like a credit card or writing a check from a checking account. Online lenders make it possible to directly deposit funds into your business checking account through an online portal.
Tips for Successfully Managing a Business Credit Line
Like any revolving line of credit, it’s important to thoughtfully manage your business line of credit. Here are three suggestions that will help you make the most of a line of credit:
- Periodically pay down your balance to zero: Whether or not your credit line comes with a fixed term that requires the balance to be paid in full at the end of the term, it’s a good idea to periodically make sure you pay the balance down to zero. This demonstrates to your lender and the business credit bureaus that you can appropriately use short-term borrowed capital.
- Establish your credit line before you need it: The best time to start the process of applying for a business credit line is before you need it. Lenders are more likely to approve your application when your cash flow is strong and your business isn’t in a bind for extra cash.
- Use it, pay it off, use it again: Using your credit line and staying current on your periodic payments will help you build a stronger business credit profile and make it easier to access the capital you need for other business purposes.
If you’d like to find out if an OnDeck business line of credit makes sense for you and your business, you can start HERE.