There Are Different Types of Business Lines of Credit. Which One Is Right For You And Your Business
Business lines of credit are a great solution if you need access to short-term funds or want to build credit. What is a business line of credit? Think of a business line of credit is like a credit card for your business.
It’s often a revolving line of credit that you can repeatedly access. You also only have to pay interest on the funds you borrow. In some cases, business lines of credit preapprove you for a set amount but aren’t revolving. In other words, the amount is not reusable.
Unfortunately, business lines of credit typically have higher interest rates and come with lower borrowing limits. They also have shorter repayment periods. However, they can be easier to qualify for. They can also be better fit for small business owners looking for ways to manage their cash flow.
Here’s a look at the types of lines of credit you could choose.
Secured Business Lines of Credit
Secured business lines of credit require collateral. This is an asset you own that you’re willing to forfeit to the lender if you fail to pay back your debt. This is similar to a mortgage lien on your home.
When you secure a loan or line of credit, the lender places a lien on the collateral. This is a legal notice that gives the lender the right to take your asset if you stop making payments. The lender can then sell it to recover any debt you owe.
Putting up some collateral for your business line of credit can make it easier to get approved. This makes them more accessible to business owners with poor credit, startups and other business owners that may not qualify for an unsecured line of credit. Securing the line of credit with collateral can also lead to more favorable terms, like a lower interest rate, increased loan limit or better repayment terms.
Securing a loan also means exposing the asset you use as collateral to the risk of seizure if you default on the line of credit. So, business owners should think carefully about what they use to secure their business line of credit. The collateral you could use for this type of credit line include:
- Commercial or personal real estate
- Company equipment or vehicles
- Inventory
- Cash
- Investments (such as bonds or stocks)
- Outstanding invoices
- Future sales or contracts
- Personal assets
- Blanket lien on all business assets
Unsecured Business Lines of Credit
The second type of business line of credit is an unsecured line, which doesn’t need collateral to back the loan. That makes it riskier for the lender, which is why business lines of credit usually come with a higher interest rate and lower lending limits than secured lines of credit.
Even though you don’t have to put up collateral, the lender may require you to sign a personal guarantee. This means you are still responsible for paying back the debt, and the lender can sue you for any unpaid balance. Even if you establish your business as a limited liability company, you are still liable for the debt once you sign a personal guarantee.
On top of all of this, an unsecured business line of credit can be harder to qualify for than a secured one. Because it heightens the risk for the lender, you generally need to show good credit and that your business has been operating for a while with a steady annual revenue.
Revolving vs. Non-Revolving Business Lines of Credit
Other types of lines of credit include revolving or non-revolving business lines of credit. Most business lines of credit are revolving, which means that you can borrow money from the available amount repeatedly. As you repay a loan, you can borrow from the credit line as many times as you need, as long as you don’t surpass the borrowing limit (called the credit limit).
In some cases, lenders will offer a non-revolving business line of credit. These lines of credit preapprove you for a loan up to a certain amount. You can use part or all of the loan for your purchases. But once you use the loan once, you won’t be able to borrow from it again.
The benefit is knowing how much you can spend on purchases since the lender preapproved you.
SBA CAPLines are an example of business lines of credit, offering both revolving and non-revolving lines. CAPLines are designed to help businesses that need funding for operational expenses, including seasonal expenses or specific contracts.
Pros and Cons of Business Lines of Credit
The main draw of business lines of credit is that once approved, you can use that credit whenever you need it. Typically, you can also borrow against the line multiple times up to the borrowing limit (unless you get a non-revolving line). Yet some lines of credit keep repayments short and may come with extra fees that you won’t see with other business loans.
Here’s a look at the top pros and cons of business lines of credit.
Pros
- Reusable credit. Most lines of credit are like having a business loan on standby. Once approved, you can borrow from it at any time and receive funds quickly. Then, you can reuse the credit as you pay down past loans.
- Only pay interest on what you use. You only get charged interest on the amounts you withdraw from your credit line and nothing more. Other loans charge interest on the entire amount.
- Often relaxed requirements to apply. Many lenders loosen requirements to get a line of credit versus other loans, such as accepting fair or bad credit.
Cons
- May have short repayment terms. Lines of credit for high-risk borrowers offer short terms from six to 24 months, although some lines go higher, like five years.
- Additional fees. Some lines of credit include costs that aren’t charged with other business loans. For example, some charge a draw fee each time you withdraw funds or a fixed monthly service fee.
- No grace period, like credit cards. Lines of credit act similar to a business credit card. But they don’t offer a grace period that lets you pay off the loan without interest like credit cards do.
Bottom Line:
If your company needs short-term financing, a business line of credit offers you an option somewhere between a business loan and a business credit card.
The types of lines of credit you can choose are either unsecured or secured by business assets. Secured lines help you get approved with bad credit or for favorable terms, while unsecured lines pose less risk that you’ll lose valuable assets if you miss payments.
You’ll pay more in interest than you would with the business loan, but you’ll have an easier, faster time securing funding.
