Business line of credit: requirements and application process for 2021

When you’re running your own business, it’s important to have sufficient capital under your belt for short-term funding needs. A business line of credit is a great option for just that.

Topics covered in this article

  • What is a business line of credit?
  • How does a business line of credit work?
  • Business line of credit vs. traditional term loans
  • Business line of credit vs. credit cards
  • Why do you need a business line of credit?
  • Business line of credit pros and cons
  • Business line of credit requirements and qualifications
  • How to apply for a business line of credit
  • Business line of credit rates

A business line of credit can be used for a multitude of reasons. It can support operational costs and supplement off-season working capital, amend gaps in cash flow, cover unexpected costs like repairs or project-based hires, as well as provide a financial cushion for emergencies.

In this article, we’ll elaborate on the benefits of a business line of credit and how it can help you fill financial gaps, seize growth opportunities, and address challenges that are oppositional to your success. We’ll also break down the application process for obtaining one, and detail what requirements and qualifications you’ll need to meet for approval.

Business line of credit: definition and general overview

A business line of credit, or credit line, is a flexible and strategic financing solution that supports the short-term capital needs of small- to medium-sized business owners.

With this type of financing, you have the flexibility to draw money from your allotted credit limit as needed, and only have to pay back (and interest on) the money you actually use.

How a business line of credit works

A business line of credit functions like a credit card. You’re given a credit limit that you can withdraw from as needed, and you only have to pay back what you use. Once you do make your repayments, your credit amount is restored and available for you to use again.

The beauty of a business line of credit is that you only pay interest on the money you use. Suppose you take one out to have on hand for emergencies. Months and months may go by where you don’t even touch it. In this case, you won’t be charged any interest on it because you only pay interest on the money you spend.

Business line of credit vs traditional term loans

When you’re applying for a business line of credit, some lenders may offer you alternative solutions, like a term loan. However, traditional term loans offer a specific amount that has to be paid back in full through fixed-monthly payments over a pre-determined period of time. It makes more sense to seek this type of funding for a specific, planned project where you know the exact amount of money you’ll need.

A business line of credit is a better option for more open-ended needs – like a cushion for emergencies – as you have the flexibility to use (and pay back) what you need when you need it.

The repayment term for paying off a term loan can range anywhere from a few months to 10 years, depending on your agreement with the bank or lender you’re working with. The frequency of your payments will also depend on your contract with the lending organization. You may be required to make repayments on a monthly, bi-monthly, weekly, or even daily basis.

Whereas a business line of credit is ideal for short-term funding needs, business term loans are ideal for long-term funding needs – things like opening a new store, purchasing new vehicles for a delivery service, or mapping out a big office renovation to support internal functions.

Business line of credit vs credit card

Given that a business line of credit functions like a credit card, you may be wondering what the difference is between that and an actual credit card. The primary difference is that a line of credit allows you to borrow money against a revolving credit line, and a credit card lets you make purchases that you then pay back.

A business line of credit will typically offer higher credit limits and lower interest rates, compared to credit cards. However, most credit cards offer reward programs – anything from freebies to discounts and rebates, which lines of credit do not offer.

It is much more difficult to get cash advances using a credit card, not to mention the ceiling-high fees that come with them, when you want to pay outsourcing services or any other intangible needs. On the other hand, a business line of credit is usually deposited into a business account, which you can easily access at any time and use for immediate needs.

You can actually use your business line of credit to pay off large balances on your business credit card. Your credit line can be a smart debt consolidation tool to help you pay off all your debts upfront. Just remember that whether you’re getting a loan, a credit card, a business line of credit, or any other type of financing, failing to make repayments on time will hurt your credit score.

Acquiring debts is not a bad thing as long as you are responsible for making your payments on time as this will boost your score. Plus, proving you are a reliable borrower to lenders may entice them to increase your credit limit should you need more cash reserves in the future.

Why do you need a business line of credit?

A credit line can be beneficial to business owners who need to pay for urgent expenses without hurting their cash flow or affecting the budget they’ve allocated for something more important.

Furthermore, it gives you peace of mind knowing you’ll have more than enough financial resources to use should you need to temporarily scale your business up to meet project demands or fund limited-time revenue-generating projects.

A business line of credit is a revolving loan that guarantees you a fixed amount of capital for the following needs:

  • Growing your inventory
  • Purchasing new equipment to support operations
  • Outsourcing professionals for time-bound projects
  • Repairing equipment that’s essential to your day-to-day functions
  • Financing a marketing campaign
  • Paying for unexpected expenses

Business line of credit pros and cons

There is no doubt that a business line of credit works wonders. It can bridge gaps in your capital and provide you with more than enough funds to keep your operations running smoothly.

However, as with any type of outside financing option, it does come with certain downsides. Here, we’ve broken down the pros and cons of a business line of credit to help you determine if it’s the right option for you.

Pros of business line of credit

1. Ensure healthy cash flow

If you run a retail business, chances are you’re most busy during the holiday season. While you have more money coming in during this period, it also requires more money going out. You have to have scale up your inventory to meet the growing demand and hire seasonal employees, etc.

A business line of credit is a great strategic financial tool to balance your cash flow. You’ll be better prepared in the high-demand seasons, but also during the slower months when your costs go back down but so does your income.

2. Pay only for what you use

A business line of credit gives your business access to a maximum amount of funds that you can use as you need. And since you only pay interest on the amount you do use, there’s no pressure to overspend or use the money within a certain period of time.

In some instances, you and your lender can come to terms with the re-payment schedule without incurring penalties.

3. Seize business opportunities as they come

If your cash flow is weak, you may miss growth opportunities that could potentially change the trajectory of your business. You never know when a new project could come your way. The last thing you want is to have to turn it away because you don’t have the means to complete it.

When presented with opportunities to grow, a business line of credit could be the difference between having to say no and being able to say yes.

4. Helps boost your business’ credit score

Small businesses often find it difficult to apply for traditional loans mainly because they are proven to be a riskier investment. They may have a lower credit score or simply haven’t been in business long enough to build a healthy credit history.

A business line of credit can help entrepreneurs build their credit history. Just make sure to stay on track of your repayments to grow your score.

Cons of business line of credit

1. Pay charges and fees

One of the disadvantages of a business line of credit is having to pay for interest charges.

As ideal as the ‘pay-as-you-go’ format looks to many small business owners, the interest charges can quickly add up over time.

Not all lenders offer the same interest rates, so you need to do your research and find a financial institution that won’t charge you beyond what you’re capable of paying. Make sure you are clear on all fees and charges you’ll have to pay before signing anything.

2. At risk for fund misuse

Because a business line of credit can be deposited anytime for any need you see coming, it can be tempting to spend more than you should. If you’re not careful, you may end up paying more than you’d planned to.

If you have already acquired significant debt or you haven’t paid back what you have previously withdrawn from the original amount, this might not be the right time to take out more money from your account.

Be extra vigilant and cautious about your spending, even when you know that you can repay the balance sometime in the future. If you’re not careful, you might experience cash flow shortages and won’t have enough money for important expenses.

3. May be difficult to qualify for

Not everyone qualifies for a business line of credit, so you have to prepare all the necessary documents to help lenders decide if you’re worthy of their time and money.

The application goes beyond pulling your credit history, although this makes a significant contribution to your application.

Below, we will discuss the business line of credit requirements and qualifications to help you assess if this is the right time for you to apply.

Business line of credit requirements and qualifications

The standard qualifications to secure a business line of credit are your personal credit history, and any documentation proving the amount of time you’ve been in business and your business’ cash flow.

In most instances, lenders will ask for your annual revenue as well as any supporting documents that prove the financial health of your business.

Banks will require you to be in business for a minimum of two years to qualify for a business line of credit. If you’re applying with credit unions and online lenders, this time minimum requirement can range from six months up to one year. You also need to have a minimum of $25,000 in annual revenue and a credit score of 500 or higher.

Those seeking a larger line of credit may be asked to put up collateral in order to obtain the loan. This will be seized by the lender if you fail to repay your balance. Generally speaking, lenders are more comfortable providing borrowers a business line of credit if there is collateral involved.

Collateral allows business owners to secure larger credit lines, better rates, and more liquidity, plus it can increase their chances of being approved for the line of credit. The most commonly used collaterals are machineries and equipment, accounts receivable, inventory, and purchase orders.

It’s important to do your research to assess which lending institution requires the documents you already have on-hand, especially when you need a business line of credit ASAP.

Related Topic: Factors to Consider When Choosing a Business Line of Credit

How to apply for a business line of credit

When applying for a business line of credit with SMB Compass, all you need to do is fill out a one-page application form and provide six months’ worth of bank statements. We do require that you be in business for a minimum of two years and have a positive personal credit score.

SMB Compass lending has advisors available to speak with you directly to assess your profile and walk you through the entire application process in detail.

As a rule of thumb, you should apply for a business line of credit while your business is succeeding since the rates will be reflective of your company’s revenue performance.

In general, lenders will check how diligent you are in paying back your past loans and how you’ve used any past credit with other lenders. In some instances, a lender might even check your own personal spending to see if you are keeping up with your payments.

Here’s what you have to keep in mind. If your business already has an outstanding revenue performance and good credit – meaning you do not have any cases of late payments or delinquencies – plus you, the business owner, has a strong personal credit history, you will have a higher chance of getting approved for a business line of credit.

If you get approved for a business line of credit with SMB Compass, the funds can reach your account within 24 hours.

How much will a business line of credit cost you?

The rates for a business line of credit vary depending on the lender and the borrower’s profile. Some lending companies offer a business line of credit with rates ranging from 5.25% to 29.99%.

That said, your credit rates are determined by the following factors:

  • Your personal credit history
  • The business’ current and historical cash flow
  • The business’ annual revenue
  • Current industry standards
  • The business’ credit history
  • Years in business
  • Trade credits
  • Customer diversity

Usually, the lending company evaluates how risky it will be to approve your business line of credit application.

They want to see your history of borrowing and repaying loans. If your business has never acquired a loan in the past, lenders will check your personal credit history to assess it. They might even require a personal guarantee or collateral before securing you the loan.

When you pledge collateral, it will reduce the amount of risk because you give an important asset to the lender in exchange for the credit line.

Is a business line of credit for you?

A business line of credit is a great option for you if you need to fund short-term needs, or if you simply want to secure your business with enough funds for emergency cases.

Just remember to make sure that your business’ financial health as well as your persona credit portfolio are credible enough to get a yes from lenders before you go through the work of applying.

Don’t forget to research different lenders and weigh the benefits of working with one over another. Check out the different financing options available to you and see which one best suits your needs, and which will save you more money in the long run.

If you’re ready to apply for a business line of credit, simply go here to get started.

Serine Alejandro
Serine is a graduate of Journalism from one of the most prestigious universities. She has broad experience in public relations and marketing communications for the lifestyle, travel, tech, and banking industries. She is now a co-owner of a growing condiments business, a manager of her family’s pharmacy, and a full-time writer for SMB Compass.

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