A business line of credit is a flexible form of financing that allows business owners to borrow money as needed, rather than receiving funds as a lump-sum payment such as with a small business loan. Instead of paying interest on the entire credit line, borrowers owe interest only on the funds they use.
There are two types of business lines of credit:
- Secured. A secured business line of credit requires you to pledge collateral—which is something of value, like accounts receivable or inventory—that a lender can seize if you fail to repay what you borrow.
- Unsecured. An unsecured business line of credit doesn’t require you to pledge collateral. However, a lender may require a personal guarantee, which means you accept personal responsibility for repaying the loan if the business is unable to make payments. This could affect your personal credit, too.
How Business Lines of Credit Work
When you get a business line of credit, you’ll receive a credit limit you can borrow against in the future. Instead of receiving the full amount upfront, as in the case of a business loan, borrowers get the ability to withdraw what they need over time, known as the draw period.
Unlike a traditional business loan, borrowers are only responsible for paying interest on the amount they borrow—not the total credit limit. After the draw period, which typically lasts 12 to 24 months but can sometimes go up to five years, the repayment period starts and the borrower can no longer withdraw funds. The borrower must pay off the outstanding balance and any interest by a fixed date, which can range anywhere from six months to five years.
How to Choose a Business Line of Credit
Keep these factors in mind when choosing a business line of credit:
- Eligibility requirements. While requirements can vary by lender, most minimum requirements for your business’ credit score, length of time in business and annual company revenue. Traditional lenders, like banks, often have more stringent requirements than online lenders. For example, while banks often require you to have at least two years in business, some online lenders require you to only have a minimum operating time of six months.
- Line of credit amount. Maximum credit limits also vary by lender. When choosing a lender, make sure it offers a credit limit that matches your business’ needs.
- Funding speed. The time it takes for a lender to issue your funds also varies. While some lenders can issue your funds as soon as the same business day, some lenders take longer. If you need funds fast, choose a lender that’s known for quick funding.
- Repayment terms. Once your draw period ends, a lender will likely require you to repay the amount you borrowed on a monthly basis. However, the amount of time you have to repay what you borrow—the repayment term—varies. Pick a lender that offers a repayment term that best suits your business.
Fees. Common fees include origination fees for processing your loan application, annual fees and monthly maintenance fees. Make sure you understand what fees a lender charges to get an idea of what your total borrowing costs will be. An easy way to do this is to look at the annual percentage rates (APRs) a lender offers—it measures interest, plus fees.