A business line of credit offers small business owners flexible, short-term funding to manage various expenses, such as payroll or inventory purchases.

This type of credit line is popular due to its adaptability, allowing businesses to draw funds as needed. According to the Federal Reserve Banks’ 2023 Small Business Credit Survey, lines of credit are the most sought-after financing option, making up 43 percent of all applications from American business owners.

Continue reading to explore how a business line of credit works and determine if it’s the right financing solution for your business needs.

What is a business line of credit?

A business line of credit is a flexible financing option that operates similarly to a business credit card. Approved borrowers receive a credit limit and can draw funds as needed, paying interest only on the amount they use. Access to funds is usually available through a business checking account or a mobile app.

Unlike traditional or term business loans, which provide a lump sum and are repaid with interest over time, a business line of credit is renewable. As you make repayments, the available credit is replenished, much like the credit limit on a credit card. Business lines of credit are typically offered for a term ranging from several months to several years, depending on the lender.

How do business lines of credit work?

Business lines of credit typically offer smaller loan amounts compared to traditional business loans and can be funded more quickly. While traditional banks may take days or even weeks to disburse funds, many online lenders can provide access to money within a single business day.

Repayment terms vary widely among lenders, ranging from just a few weeks to several years. Interest rates on business lines of credit are usually higher than those on traditional business loans. Your specific rate will be influenced by factors such as your credit history, business longevity, and annual revenue.

Common fees associated with business lines of credit include an annual fee, an origination fee at the time of application, a maintenance or monthly fee, and draw fees each time you access the line of credit.

Secured vs. unsecured line of credit

A business line of credit can be either secured or unsecured. A secured line of credit requires collateral, such as cash, investments, or real estate. Providing collateral often results in more favorable loan terms and a lower interest rate.

To qualify for an unsecured business line of credit, your business typically needs a strong financial profile, including a good credit score, at least two years in operation, and consistent or growing annual revenue. Since unsecured lines of credit present a higher risk to lenders, they often come with slightly higher interest rates.

Alternatively, you can consider an SBA business line of credit, known as SBA CAPLines. These are designed for businesses that may not qualify for traditional lines of credit. Backed by an SBA guarantee, these lines of credit often have a higher chance of approval due to the reduced risk for lenders.

Can I get a business line of credit with bad credit?

Yes, it’s possible to secure a business line of credit with a low credit score. Some lenders, particularly online lenders, may work with borrowers who have scores as low as 500. However, opting for bad credit financing often means accepting less favorable terms, including:

  • Lower Loan Amounts: To mitigate risk, lenders may restrict the loan amounts available. You might be limited to loans of $100,000 or less, depending on factors such as your business revenue and duration of operation.
  • More Frequent Repayments: With bad credit, you may need to repay your borrowed amount more frequently, such as on a weekly or biweekly basis.
  • Shorter Draw Periods and Repayment Terms: Lenders may offer only short-term loans, meaning you can use the line of credit for a limited period, and you might need to repay it within six to 18 months.
  • Higher Factor Rates: Some lenders charge factor rates instead of traditional interest rates for bad credit borrowers, which can increase the overall cost of borrowing.
  • Fewer Options: With bad credit, you may have fewer financing options and might not be eligible for unsecured business lines of credit.

Can I get a startup business line of credit?

Online lenders provide business lines of credit to startups, with some requiring as little as six months in business. For those in the early stages, consider:

  • Fundible
  • Fundbox

If your business has been operational for over a year, you’ll have additional options, including:

  • Backd
  • OnDeck

For businesses newer than two years with strong credit (a personal score of 680 or higher), Wells Fargo offers the Small Business Advantage® line of credit. Bank of America also provides a cash-secured business line of credit, which can help you build credit for more affordable financing in the future.

Requirements for a business line of credit

When applying for a small business line of credit, lenders will evaluate several key factors to determine your eligibility:

  • Credit Score: Both your personal and business credit scores are considered. While it’s possible to secure a line of credit with a lower credit score, lenders generally prefer fair-to-excellent credit. Lower credit scores can lead to higher interest rates and fees and may limit your options for unsecured lines of credit.
  • Annual Revenue: Lenders typically require a minimum annual revenue. Some are flexible and may accept businesses with annual revenues as low as $50,000, but many prefer a revenue of at least $100,000.
  • Time in Business: The required time in business can vary by lender, but most look for a minimum of six months to two years.
  • Collateral: Offering collateral can help you qualify for a secured line of credit, which often comes with lower interest rates.

Pros and cons of a business line of credit

Like many financial tools, a small business line of credit has its advantages and disadvantages. It’s crucial to consider these factors carefully before deciding if it’s right for your business.

Pros

  • Enhanced Cash Flow: Helps manage cash flow by providing access to funds when needed.
  • Accessibility: Easily accessible funds can be drawn as required.
  • Lender Relationship: Provides an opportunity to build a relationship with your lender.

Cons

  • Fees: May incur various fees, such as annual or draw fees.
  • Higher Interest Rates: Often comes with higher interest rates compared to traditional loans.
  • Shorter Repayment Terms: May have shorter repayment periods, leading to more frequent payments.

What to consider when getting a business line of credit

A business line of credit is ideal for managing small to moderate expenses and can be a great option if you anticipate needing access to funds in the future. Since most lines of credit are revolving, you can borrow, repay, and borrow again, with your available credit replenishing as you make repayments.

Lines of credit often have more flexible application requirements compared to traditional business loans. Even if your personal credit is only fair or your revenue is modest, you might still find suitable options.

However, if you need funding for a specific, one-time expense, a business term loan might be a better choice. For instance, if you’re looking to purchase equipment, an equipment loan could be more appropriate. With a term loan, you receive a lump sum upfront to cover the purchase, and the equipment itself serves as collateral, which can potentially result in a lower interest rate.

In Conclusion

A small business line of credit offers a flexible solution for managing inconsistent cash flow. However, as with any financing option, it’s important to weigh the risks. By comparing lenders, you can secure more favorable rates and terms, potentially saving money over the long term.

Although credit limits may be lower compared to traditional business loans, lines of credit often provide quicker access to funds. Additionally, you can repeatedly draw from the line without needing to reapply for new funding.