How Secured and Unsecured Business Line of Credit Work
Business line of credit is a good option that business owners can consider when scouting for ways to finance their business operations. Generally, financing is one of the challenges facing small business owners. And we all know how important cash can be to any business. No matter how profitable a business is, if there is no fund to finance it, it may soon go into extinction. For this reason, it is good that business owners understand different sources through which they can raise fund to keep their business afloat. One of the sources of finance is the business line of credit.
What is Business Line of Credit?
Business line of credit is a form of loan that comes with some flexibility which traditional loans do not provide. Just like credit cards, business line of credit is a revolving loan that allow you to borrow up to a certain limit. For instance, you can get a line of credit for $120,000. What this means is that, you can borrow up to a limit of $120,000. However, it is not compulsory that you should withdraw the entire amount at a time. Your drawing will be based on your business needs per time. The main advantage of business line of credit over traditional loans is that, you will only need to pay interest on the amount drawn from the approved credit limit. Although interest is only charged once you use the line, there may be a monthly maintenance fee for letting your line of credit sit unused. For any line of credit you consider you need to carefully read the terms offered by the bank or lender to make sure you understand any associated fees.
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In the case of traditional loans, the entire amount is released to you in bulk. And you will need to pay interest on the entire amount whether you actually utilize it or not. For business line of credit, you can keep drawing and repaying funds based on your cash flows. You can even repay the entire amount you borrow if you have the money. This will help you save interest expenses. The only thing is that, you will not be able to exceed your credit limit. Once you pay back the funds you’ve withdrawn, the available credit resets to its original limit. Business line of credit is essentially a short term funding. It can be used to support financing for operational expenses like supplies and payroll or for increasing inventory. Cyclical businesses often rely on line of credit as a source of off-season working capital.
Types of Business Line of Credit
Basically, there are two types of business line of credit namely unsecured and secured business line of credit. The two work the same way. The only difference between them is that, for unsecured business line of credit, you will not be asked to pledge collateral. But in the case of secured business line of credit, you will be requested to pledge security before your application can be approved. The security can be real estate, equipment, inventory or receivables.
Unsecured line of credit usually comes with lower credit limit and higher interest rates. So, if you desire to raise large amount, the lender may require that you put up assets as collateral. This will reduce the risks that the lender has to undertake. With secured line of credit, you will also be able to enjoy lower interest rate. But the danger with secured line of credit is that, if you are unable to pay back the credit, your assets can be repossessed. Therefore, before you opt for secured line of credit, you should be certain that you will be able to pay back the credit. Otherwise, you stand the risk of losing your asset.
Business line of credit, whether unsecured or secured, is actually a good way to start building good credit rating for your business. You may not need to start with a large amount. If you are faithful and consistent in paying off the credit, you may be able to qualify for better loan terms in the future.
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How to Get Business Line of Credit
If you want to apply for this type of business financing, you will need to approach your bank or alternative lender. The requirements may differ from one bank to the other. But generally, you will be required to provide your driver’s license, the financial statements of your business, bank account information, personal and business tax returns, personal and business credit score, information about any other financing you are paying off and collateral in case of secured business line of credit. You may need to compare offers from different lenders. When searching for the right provider for your small business, it’s important to know what your goals are for having the line of credit. This will help you get a good deal.
Pros and Cons of Business Line of Credit
Before I start discussing the pros and cons of business line of credit, let me briefly recap by saying that this form of financing is good when you are not sure about the amount you need to finance your project. If you go for a traditional loan, you may borrow a large amount which you may not really need. This will force you to pay interest on the loan you didn’t utilize. Line of credit is also good for seasonal business as it could help you bridge your busy seasons. At times, you may realize that you need extra capital to ramp up new customer contracts or projects. This type of financing can quickly come to your aid.
Pros of Business Line of Credit
- The money is readily available. You don’t need to start applying for fresh loan each time you need funds. This will save you time and paperwork. Also, it helps you avoid additional credit checks.
- Low interest costs: Interest expenses are only incurred when line of credit is used.
- Multiple uses: You can use a business line of credit for any number of business purposes ranging from financing your operational expenses to project financing.
- Available to borrowers with bad credit. If you have collateral to pledge, you can easily get approval for the credit.
- It can be used to build or repair credit over time.
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Cons of Business Line of Credit
- Maintenance fee: Apart from the interest you pay on the amount drawn, you may be charged maintenance fee to keep the business line of credit open. This does not have anything to do whether you use the credit or not.
- Variable interest rates: Unlike traditional loans that attract fixed interest rate, interest rates on line of credit are usually variable. The rates fluctuate with the economy.