March 6, 2019 | Last Updated on: June 27, 2023
A line of credit is an ongoing business loan from which you may borrow any amount up to a limit, as long as you pay back the principle .It offers businesses a way to access funds quickly when they need to. Lines of credit can be extremely beneficial when a business needs a source of cash flow quickly in order to keep the doors open. Since you don’t have to reapply each time you withdraw funds – as you would if you took at a typical term loan – , you don’t have to worry about the long application and approval process that comes with a traditional loan. An open line of credit can be especially helpful in case of emergency, such as the permanent breakdown of a business vehicle or piece of equipment. Say this happened to you. Without an open line of credit, your business would have to apply for a loan to replace the item. It could take days for your business to get approved, and then, afterward, it could take even longer for you to access the funds. Meanwhile, your business could be unable to operate. With your business shut down, you could lose out on valuable – or even vital – revenues and profit. But with a line of credit, you would be able to access funds immediately and get your business back up and running, faster. Lines of credit are some of the most popular sources of funds sought by small businesses. While the 2018 Federal Reserve Banks Small Business survey will be released later this year, the 2017 survey found that of the small businesses that applied for funding of some form, 43% applied for a line of credit. Of those that applied for a line of credit, 69% were approved. While lines of credit are great for many of the reasons listed above, they are not meant to be used for projects or purchases that require a large amount of funding. Instead, they are designed as a safety net: something for businesses to rely on when they need quick, easy access to limited funds. Since lines of credit typically range from $2,500 to $175,000, they aren’t right for business that are looking to fund large projects or endeavors. These businesses should pursue approval for traditional term loans instead.
An unsecured line of credit does not require that you put up collateral to back (secure) the loan. Collateral is an asset or assets that the lender can claim if the borrower can’t pay back the loan. Lenders do this in order to minimize their risk in giving you the loan. Clearly, securing a line of credit (say, with your house or car) can put you, the borrower, at risk and make the consequences of defaulting even more severe for you. This is what can make unsecured lines of credit attractive to small business owners.
And now, the down side. While unsecured lines of credit can be beneficial, especially for businesses without the assets to present as collateral, they typically have less favorable terms than secured lines of credit. Unsecured lines of credit tend to have higher interest rates, lower borrowing limits, and shorter repayment timeframes. Be sure to watch out for other restrictions in the agreement between your business and the lender. One thing to keep an eye on is a common alternative to collateral called a personal guarantee. A personal guarantee is another way a lender can minimize their risk. A personal guarantee puts the responsibility to pay back the loan on you no matter what. While the business is always responsible to pay back the loan initially, a personal guarantee means that if your business defaults, the debt is still your responsibility. This can be a very dangerous agreement, putting your personal financial security at risk. It is important that you understand the exact details of any personal guarantee before you agree to it .
Lines of credit are available from most lenders, including both traditional brick-and-mortar banks and alternative lenders, such as online lenders. With all these options, you should spend time shopping around so that you can find the best loan for your business and its needs.
Sure. Business credit cards can be a great way for a new business to start building a good credit rating with a solid foundation. What makes them a nice option for new companies is that credit card providers usually have less stringent standards than typical lenders. That said, you’ll want to make sure your business is able to pay all your charges in full at the end of each month. Failure to do so can be disastrous for small businesses, loading them with debt, and making it much harder for them to obtain good loans with low interest rates in the future. It can become a very difficult to solve problem that can take years to ultimately fix.
The Federal Reserve Bank found in their 2017 survey of small businesses that, of the businesses that did not apply for funding in the prior 12 months, 17% chose not to due to being discouraged. These businesses decided not to apply because they believed they would be turned down. While being denied a loan is very much a possible outcome, never applying in the first place guarantees your business will not receive the funding you desire. So, while it is important to be realistic about everything from application fees to your company’s overall situation, it does not help you to believe that there are no options for your business.
At the end of that day, each business is different, so you’ll want to make sure you research and understand what is best for your individual business. All loans can lead to insurmountable debt, so it is important that you are responsible and cautious when you take one. Lines of credit are just another option for businesses, and not all businesses need them. However, if a line of credit sounds like something that would be beneficial to your company, by all means, consider one the next time you decide to pursue funding for your business .
