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Need to purchase inventory or cover an unexpected expense and you’re short on cash? A business line of credit (LOC) may be the way to go. A business credit line works much like a regular consumer credit card – the lender provides you with a credit limit that you can borrow against as you see fit. You then make regular payments and only pay interest on the amount that you actually use. As you pay down the outstanding balance, you can “re-borrow” by accessing the available credit amount.
With a business line of credit, you’re able to draw against a revolving line as you need to and “re-borrow” funds as you pay down the balance. It’s an ideal solution for quickly meeting short-term working capital needs. A standard business term loan provides money in a lump sum and you’ll need to reapply should you require additional funding. Term loans are best suited for one-time funding of large purchases.
Business lines of credit provide more flexibility than term loans and can actually save you money. You only pay interest on the portion of the credit line that you use and most lenders will allow you to repay your full balance early to save on interest costs. With a term loan, you pay interest (often fully amortized) on the entire amount borrowed along with origination fees and closing costs.
The qualification requirements for both of these funding options are similar. To qualify for either a business line of credit or term loan, a lender will typically take the following into consideration when making an approval decision:
For the term loan, the lender will also want to know how you plan to use the funds.
Because a line of credit can be such a flexible and affordable funding option, a recent survey by the National Federation of Independent Business (NFIB) found that more than half of all small business owners currently have an open credit line that they use for business purposes. These businesses rely on borrowed funds as their primary funding source. Trade credit is also essential to the operations of many small companies.
If you’ve determined that a business line of credit best meets your funding needs, you can apply at a traditional lender such as a bank or credit union, or at an online lender. Knowing beforehand what your goals are for the LOC will help you to select the right lender.
Lines of credit typically have lower borrowing limits than business term loans and aren’t ideal for large expenditures. If you would still prefer an LOC and require more than $100,000 in funding, consider applying for a business line of credit at a traditional bank. If your funding needs are less than $100,000, an online lender may be your best bet.
Is there a limited-time opportunity that you want to take advantage of? Need to cover this week’s payroll? An online lender can generally fund you in as little as one day after approval. Online lenders can quickly provide funds through short-term loans as well as lines of credit.
If you want to obtain a line of credit without having to pledge collateral to secure it, traditional banks may not be able to provide the funding you need. Banks generally have higher minimum requirements which often include pledging specific collateral. For lower credit limit lines, some online lenders will use criteria other than available collateral (such as being in business for at least one year) to make their funding decisions.
Lines of credit offered by banks often have lower interest rates than those offered by online lenders. However, banks typically offer longer repayment terms so you’ll end up paying more in interest in the long run. An online lender will offer a shorter repayment term so, although the interest rate is higher, your total interest costs will end up being lower. Also, the bank’s application process can be lengthy so if you’re seeking funding to take advantage of a profitable time-sensitive business opportunity, an online lender may be the best option.
To qualify for a business line of credit, most lenders will take your credit score, annual revenue, time in business and available collateral into consideration. The exact qualifications, however, will vary widely from one lender to the next as banks and online lenders take different approaches to small business funding.
Banks are generally risk-averse and have more stringent qualification requirements than online lenders. You’ll need to be a pretty solid borrower to get approved for a business line of credit. Even if you meet the strict requirements of a traditional bank, you may find it difficult to obtain an approval unless you bring other business to the bank (i.e. checking or merchant account). The profitability of a line of credit isn’t readily predictable so banks often want a prospective borrower to have other relationships with them. This may help you to get approved and get a more favorable interest rate.
The typical qualifications for a business line of credit from a traditional bank are:
Along with your application, banks will typically require the following documents: bank statements, personal and business tax returns, and financial statements such as a balance sheet and profit-and-loss statements. As the business owner, most banks will also evaluate you personally as a way of ensuring that you’re a good credit risk.
Don’t be surprised if you’re asked to provide a resume which outlines your professional experience and shows your ability to operate a business in your industry. A background check may also be conducted to determine if there are any issues like past criminal activity that could affect the approval decision.
The Small Business Administration (SBA) offers several programs to help business owners obtain needed financing. If the bank participates in the SBA 7(a) loan program, it may also offer SBA CAPLines. SBA CAPLines is a program that provides lines of credit with limits up to $5 million but borrowers will still need to meet the SBA’s somewhat high qualification requirements. Keep in mind that the SBA doesn’t provide the line of credit but acts as a guarantor of last resort to cover 90% of the line of credit value in the event of default. If you decide to go this route, you’ll be dealing with a government entity so be prepared for a lot of paperwork.
Online lenders typically have more relaxed requirements than banks. However, they’re likely to charge much higher interest rates and the credit limits are often lower. Some online lenders set the maximum credit limit as a percentage of annual business revenue. For example, if your annual revenue is $200,000 and the lender sets the maximum percentage at 20%, your credit limit can’t exceed $40,000.
The typical qualifications for a business line of credit from an online lender are:
Traditional lenders such as banks and credit unions typically offer the lowest interest rates which often range from 9% to 25%. While the interest rates are lower than those of online lenders, their repayment terms are generally longer. You’ll save money in monthly payments but the overall cost of the credit line will end up being higher.
Obtaining a line of credit from an online lender can cost anywhere from 30% to 50% in interest. Quickly repaying the outstanding balance will help you to save on interest costs.
Banks may be willing to offer larger lines of credit at lower interest rates but they’ll often require that the lines be secured. Short-term assets like accounts receivable and inventory are typically required since lines of credit are considered to be short-term liabilities. Your business savings or checking account can also be pledged with the requirement that you maintain a certain balance while the line of credit is open.
Most banks will file a UCC lien against the pledged collateral and typically will not take a second lien position. The bank may ask you to refinance the outstanding loan and then use the previously pledged assets as collateral for the new line of credit with them. This would place the bank in the first lien position on your assets should you default.
If your credit, as the business owner, is stellar and your business is showing considerable and steady growth, you may be able to obtain an unsecured line of credit. On unsecured lines, the interest rates are often higher and the credit limit is usually smaller.
Online lenders typically don’t require the pledging of collateral for lower credit limit lines. When collateral is required, they will often place a blanket lien on all of your business assets. While the blanket lien is in effect, it can be difficult to obtain additional funding unless you’re willing to refinance and consolidate the debt.
If you’re able to qualify, banks offer the best repayment terms. Many banks will allow you one to five years to repay the money and will give you the option of interest-only payments. If your line of credit has a clean-up requirement, however, you will have to repay the entire outstanding line of credit once a year.
The repayment terms offered by online lenders are often shorter than those of banks. The repayment period can be as short as three months and as long as 36 months. Every time you draw from the credit line, this time restarts.
A business credit card is also a line of credit but it differs from a traditional business LOC in a number of ways. A business line of credit has a higher credit limit and may be secured by collateral. When you make a draw against it, actual cash is placed in your bank account. If you get cash from a business credit card, you’ll likely be charged fees and a higher APR for cash advances. Annual fees and late payment fees are commonly assessed on business credit cards.
As part of the application process, the owner’s personal credit is checked but the credit card is issued in the name of the business. The owner is responsible, however, for making payments and missed or late payments will be reflected on the owner’s personal credit report.
Business credit cards are best for small ongoing expenses such as office supplies and gas. Newer businesses without established finances may find it easier to qualify for a business credit card than a business line of credit. Similar to regular consumer credit cards, rewards and cash back on purchases can be earned on these credit cards.
A business line of credit can be an affordable solution for short-term working capital and handling emergencies. To get the best interest rates and terms, it’s best to apply for an LOC when your credit score and revenue are favorable. If your credit score needs work before you can qualify for an LOC, start taking steps towards improving it so that you’ll have more options when you need funding.
As a business owner, you should have an idea of what your expenses are going to be for the next 12 months. If you see that you’ll need additional working capital within that time frame, plan to start the application process sooner than later. If you’re considering a bank as a funding source, this is especially important since their application process can be lengthy.
If you’re approved for a business line of credit, be diligent about making timely payments. Lenders can reduce your credit limit or cancel your line altogether for late or missed payments. This could cause considerable hardship for your business if you can’t access funds when you need them most.
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