How Does a Small Business Line of Credit Work?
A small business line of credit is pretty similar to a personal line of credit (like your credit card).
A bank or lender gives you access to a specific amount of financing set by a credit limit, which you can draw from whenever you want or need.
However, you don’t make payments or incur any interest until you actually tap into those funds. You pay for what you use, in other words, and there are no fees for repaying early.
Business lines of credit can come secured—backed by collateral like inventory, accounts receivable, and so on—or unsecured, backed only by your personal guarantee.
Small Business Lines of Credit Are ‘Revolving’
This sort of financing often gets referred to as revolving credit because you can tap into it again and again. Once you repay what you’ve spent, you can continue to draw capital from your line of credit.
For instance, say you’re given access to a $60,000 small business line of credit. You decide to take out $40,000, keeping the other $20,000 in the pool of available funds.
Once you pay that $40,000 back (plus interest), you’ll have the whole $60,000 at your fingertips again—without having to apply for another loan. Therefore, revolving small business lines of credit don’t really have term lengths—you can withdraw and pay back those funds indefinitely, as long as your lender believes that you’re a responsible borrower.
The time and energy you save is one of the biggest benefits to a business line of credit.
Although most business lines of credit are traditional revolving credit products, some will not automatically renew after you’ve fully repaid what you owe. Some non-revolving lenders will have you reapply to renew your line of credit. Assuming you’ve remained in good graces with your lender, reapplying should be an easy process.
Note that you’ll sometimes hear lines of credit differentiated as short-term lines of credit and medium-term lines of credit. The differences are mostly in their minimum qualifications, maximum fund amounts, and interest rates.
The longest-term lines of credit typically come from a traditional bank. Medium-term lines of credit and short-term lines of credit are typically found with online lenders.
Business Lines of Credit vs. Traditional Term Loans
So what sets a business line of credit apart from a traditional term loan?
To start with, business lines of credit usually come with lower interest rates and closing costs than traditional term loans of similar sizes.
But on the other hand, if you’re late with a payment or go over your credit limit, that interest rate could spike pretty high.
Also, traditional term loans have regular interest rates over the life of the loan, which is a major difference between term loans and business lines of credit.
If you’re comparing a small business line of credit with a traditional term loan, keep in mind that lines of credit tend to work better for repeated cash flow issues while term loans often make more sense when it comes to specific purchases or one-off business investments. But that doesn’t mean you can’t or shouldn’t use a business line of credit for business purchases, too.
Business Line of Credit vs. Credit Card
Although business lines of credit and business credit cards are both forms of “revolving” credit, there are a few important differences you should be aware of:
- Credit cards usually have higher interest rates.
- Credit cards charge additional fees for cash advances and, often, balance transfers.
- Credit cards typically require payments on a monthly basis while business lines of credit usually don’t.
- Lines of credit give you access to cash.
How to Use a Business Line of Credit
The biggest advantage of a business line of credit is its renewability: you can draw out funds, pay them back, and draw again.
You can use a small business line of credit for a variety of business purposes, including the following:
- Ongoing operating expenses
- Cover cash flow gaps
- Take advantage of unexpected opportunities
- Provide cushion to protect against emergencies
- Cover seasonal downturns in sales
- Make larger purchases
This flexibility is what makes a business line of credit such a valuable loan product for small business owners. If something unexpected happens, you have the money on hand to be able to deal with it.
Who Qualifies for Small Business Lines of Credit?
What sorts of businesses are eligible for this flexible financing?
Younger, less established businesses might be able to qualify for short-term lines of credit, while medium-term lines of credit are more for businesses with good credit and a solid financial history.
The maximum amount of funding available, introductory duration of the credit line, and repayment terms depend on your business’s revenues, credit rating, history, and other factors.
See If You QualifyMost customers who were approved had
**Based on past Fundera customers
Over $180K
630
Over 1 year
**Note that due to the ongoing pandemic and its impact on the economy, lenders have raised their qualification standards for the time being. Businesses seeking a line of credit should have annual revenues of at least $250,000 and a minimum 650 credit score.**
How Do You Apply for a Business Line of Credit?
A business line of credit application can be a very easy process, depending on the line of credit lender you’re working with. Online business line of credit providers have quick, streamlined applications, thanks to the use of technology in their underwriting processes. On the other hand, traditional banks have more intensive applications.
Generally speaking, online line of credit providers offer smaller, shorter-term options that will come with an easy and fast application process. Meanwhile, banks will offer larger and longer-term options might require more paperwork and could take slightly longer to fund.
Documents you need:
- Driver's license
- Voided business check
- Bank statements
- Credit score
With banks, you may also need to provide the following:
- Balance sheet
- Profit & loss statements
- Business tax returns
- Personal tax returns
What Will a Business Line of Credit Cost You?
The basic cost of a business line of credit is pretty straightforward: You only pay interest on the cash you draw.
For example, say you’re waiting on a payment from a customer, and you need to pay the bills, so you take out a $25,000 line of credit. You then use $5,000 from that line of credit to cover your debts while you wait for payment.
In this scenario, you’ll only need to pay back $5,000, plus interest accrued on that $5,000 (not the full $25,000).
If your interest rate is 11%, you’ll have to pay back $5,550 (or $5,000 plus $550 in interest).
Once that’s paid off, you can continue making additional draws up to the $25,000 maximum, only paying interest on what you’re borrowing at any given time.
Best Business Line of Credit Lenders
Now that you understand the ins and outs of business lines of credit, we’ll give you a few lenders we recommend if you’re seeking financing.
Kabbage: Best Lender for Businesses With Bad Credit
The most appealing aspect of Kabbage lines of credit is that they are very easy to qualify for and can fund in under 24 hours (in some cases, you can get funded in under five minutes).
Kabbage loan amounts range from $2,000 to $250,000 with terms between six-18 months. Note that interest rates range from 1.5% to 10%. That means you could be looking at an APR as high as 100%. However, Kabbage doesn’t charge any additional fees outside of interest.
To qualify, all you need is $50,000 in annual revenues and at least one year of business history. Kabbage typically doesn’t factor in credit score during the underwriting process.
Fundbox: Best Lender for New Businesses
Fundbox offers lower loan amounts and shorter repayment terms than Kabbage, but requires that you only have three months of business history on the books in order to qualify. With Fundbox, you can secure a line of credit with a loan amount between $1,000 and $100,000 with a 12-24 week repayment term.
Note that Fundbox requires weekly repayments, and you’ll pay an interest rate ranging from 0.5% to 0.9% of the drawn amount per week. For example, if you borrow $5,000 for 12 weeks, you’ll pay between $25 to $45 each week for 12 weeks.
Aside from the time in business requirement, borrowers who were approved for a Fundbox line of credit typically had at least $25,000 in business revenues and a 500 minimum credit score.