How to leverage a line of credit for your small business
Having access to credit can help your small business thrive. A business line of credit is often the best bet for those with short-term and occasional credit needs.
Having access to credit can help your small business thrive — even if it’s facing difficulties.
There are a number of financing options for small businesses, but a business line of credit is often the best bet for those with short-term and occasional credit needs.
A business line of credit can give your company the necessary working capital to maintain inventory, fulfill emergency orders and meet other urgent business needs. It can also help you maintain consistent cash flow, easily track business expenses, and even fund plans for expansion.
Business lines of credit are one of three main products small businesses use for financing.
When you qualify for a business line of credit, you receive a maximum amount that you can borrow against at any particular time, as per its requirements. Interest rates tend to be low, compared with those for other financing options, but they’re also likely to be variable, so your rate may increase over time.
Small-business loans allow you to borrow a lump sum for business purposes. Traditional lenders, such as banks, tend to offer them for around 5% to 12% interest — either fixed or variable — while rates from online lenders or marketplaces are often higher. Business credit cards, like personal credit cards, come with relatively high interest rates, in the range of 12.99% to 29.99%. Further, they require a personal guarantee, which means if your business fails to pay, it will impact your personal credit score.
Each financing option is important to small businesses for various reasons, but there are some key differences.
- Usage: You’ll receive the funds from a business loan all at once. But you can borrow up to your limit on a credit card or line of credit again and again — as long as you repay the lender in between.
- Payment: Business loans and credit cards both require monthly payments. But you make payments only when you use a business line of credit; no usage means zero payments.
- Interest rates: You make interest payments on the entire amount of a business loan. But you’ll pay interest only on the amount you actually borrow on a credit card or line of credit; you won’t pay interest based on your credit limit unless you’ve used it all.
- Qualifications: Business loans and lines of credit have a comprehensive set of qualification requirements, making it difficult at times for small businesses to get approved. Business credit cards are easier to qualify for.
Choosing your business line of credit
Considering their lower rates and flexible borrowing arrangements, lines of credit can be small businesses’ best bet for their short-term and recurring financing needs. They may also come with more flexible repayment options and lower closing costs than a loan.
You can apply for a secured or unsecured business line of credit. You must use hard assets, such as your home, vehicle, inventory or even business equipment, as collateral on a secured line of credit. An unsecured line of credit doesn’t involve collateral, so it’s somewhat more difficult to qualify for one. Unsecured credit lines also tend to have higher interest rates because they’re more risky for the financial institution.
To qualify for a business line of credit, focus on maintaining good personal and business credit histories. You must also prove your company’s ability to generate a positive cash flow, as lenders will consider this in judging your ability to make payments.
It may make sense to apply for a lower line of credit, maintain a positive transaction history, and then seek increases later. But you should always apply for one before you need it. After all, your line of credit is intended to support your business during its hour of need, so you shouldn’t attempt to get one when it’s already struggling.
Dmitriy Fomichenko is president and founder of Sense Financial, a provider of self-directed retirement accounts. Learn more about Dmitriy on NerdWallet’s Ask an Advisor. This article first appeared at NerdWallet.
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