Business Line of Credit: What It Is & How It Works
This article is part of a larger series on Business Financing.
A business line of credit allows a business to take draws against an established credit limit as needed rather than receiving the full amount of the loan upfront. Lenders charge interest on the amount used, and borrowers must repay it in installments. This makes lines of credit best for small business expenses, especially unexpected ones.
If you feel like a small business line of credit is the right financing option for your business, Bluevine offers business lines of credit of up to $250,000. With Bluevine’s business line of credit, the borrower pays interest only on the amount used, and there is no prepayment penalty. For more information or to apply for a business line of credit, visit Bluevine’s website.
How a Small Business Line of Credit Works
Business lines of credit are similar to credit cards in the way they work. First, a lender qualifies a business for a predetermined credit limit. Then, as long as there is unused credit available, the business can borrow against the line of credit at any time.
The key difference between credit cards and lines of credit is the length of time allowed to repay the borrowed amount. As long as minimum payments are met, credit card balances can be carried indefinitely. However, a business line of credit has a set repayment period.
Lines of credit and short-term business loans can both be used for small business expenses. However, the difference between lines of credit and short-term loans is that borrowers can draw against lines of credit as the funds are repaid while short-term business loans are paid out in full by the lender and then repaid by the borrower in installments over a fixed repayment term.
How To Select a Business Line of Credit
To get a business line of credit, you can go through either a traditional or an online lender. Both offer similar products, but there are differences in qualifications, funding amounts, and repayment terms. For more information on choosing a lender, see our article on the best small business lines of credit.
The chart below details some of the differences between online and traditional lenders:
Traditional Lender | Online Lender | |
|---|---|---|
Funding Amount | $100,000 or more | Up to $250,000 |
Funding Speed | Five days to four weeks | One to three days |
Minimum Qualifications (Personal Credit Score) | 680 FICO | 600 FICO |
Borrowing Costs | Up to 25% APR | 4.8% to 79% APR |
When choosing the right small business line of credit, consider the four steps listed below.
1. Determine the Amount You Need
Because lines of credit typically have lower borrowing limits than term loans, they are ideal for small or unexpected capital expenses. In the past, traditional lenders had higher credit limits than online lenders. However, online lenders, such as Bluevine, now offer lines of credit of up to $250,000, so consider online lenders as a viable alternative.
2. Determine How Soon You Need It
Funding speed is another area where the gap between online and traditional lenders has closed. One of the biggest advantages of online lenders has been rapid funding and availability of funds. However, most traditional lenders now have a strong online presence, so many fund loans in days rather than weeks. If you need access to funds quickly, online lenders still have the edge, albeit a smaller one than before.
3. Review the Qualification Requirements
In general, even if a borrower’s credit score is lower, online lenders will likely fund loans and lines of credit. As long as the FICO score is higher than 600, online lenders will usually work with a business that meets annual revenue and time-in-business requirements. Business owners with credit scores above 680 will likely get better terms and interest rates through both traditional and online lenders.
4. Review the Costs
When considering a business line of credit or a term loan, borrowers should keep the repayment term in mind when calculating the loan cost. Short-term loans might have higher interest rates, but the interest cost is generally lower because borrowers repay the loan in six to 18 months. The benefit of low rates on lines of credit can be offset if balances are carried for longer periods of time. To apply for a business line of credit, check out Bluevine’s line of credit product.
What a Small Business Line of Credit Can Be Used For
Small business lines of credit are best used for small expenses and unexpected costs. Lines of credit should not be used for large capital expenditures such as heavy equipment or real estate purchases. They can also be used to offer credit to your customers, especially to cover unpaid invoices. A line of credit is also beneficial for small recurring expenses, or seasonal needs.
Four examples of how small business lines of credit are used are listed below:
- Short-term working capital: Use lines of credit to make payroll or cover expenses while waiting for invoices to be paid or for seasonal business to pick up.
- Unexpected expenses: Because borrowers can draw against a line of credit at any time, it can be a safety net for unexpected expenses, such as small equipment repair or replacement.
- Unique purchasing opportunities: Having an available line of credit might allow a business to buy items that the company might not have cash on hand to purchase—for instance, something that becomes available for a limited time or in a bulk quantity. The business could save money long-term by using the line of credit to make the purchase.
- Offer trade credit to customers: Because accounts receivable invoices can often be repaid late―30 days or later―offering trade credit to customers provides a cushion to cover for these late payments. This allows the business to maintain its cash flow while waiting on those invoices.
Avoid large purchases with a business line of credit: Lines of credit should not be used for large capital expenditures like heavy equipment or real estate purchases. Credit limits usually aren’t high enough for those purchases and, if they are, the interest cost would be far more substantial than a capital term loan for a high-value purchase.
When To Apply for a Small Business Line of Credit
While a business can’t always wait for the right time to apply for a small business line of credit, if it can plan when to borrow, a business can secure strong interest rates for larger amounts of money with a reasonable repayment schedule.
There are four things to consider when trying to find the right time to apply for a business line of credit:
- When your credit score is strong: A strong credit score means the business will likely get a larger line of credit at a lower interest rate. Business owners should keep close tabs on their credit scores and work to resolve any issues before applying for new credit.
- While revenues are trending up: Regardless of whether you use a traditional or online lender, each of them has a minimum requirement for annual income. If your income is trending up, the lender can likely use a 2- or 3-year average to calculate your income. Declining revenue requires the lender to use the most recent year’s income, which can result in a declined loan application.
- When you hit a key business milestone: Lenders will look more favorably on a business as it continues to hit milestones on time in business, revenue, and credit score. As those milestones increase, lenders will offer better terms to the business.
- Before a small capital need: The better a business plans ahead on capital expenses, the more options it will have when looking for funding—it won’t have to settle for the first loan offer to come along.
Pros & Cons of a Business Line of Credit
| PROS | CONS |
|---|---|
| Draw funds whenever needed | Typically smaller amounts than term loans |
| Pay interest only on funds used | Not good for long-term or large capital expenses |
| No need to reapply for more funding | Credit limit can be reduced or canceled by the lender |
Bottom Line
Business lines of credit can be an excellent choice for businesses looking to cover small expenses and unexpected costs. Businesses should apply for financing before the need arises to secure the best rates and terms. Traditional banks typically offer higher lines of credit at better rates. However, online lenders such as Bluevine are now funding higher amounts faster than some traditional banks. Bluevine should be considered along with traditional lenders when looking for business lines of credit.
