Operate with
Lines of credit
In concept, a line of credit works much as a credit card does. Once a business applies for a credit line, a lender reviews the business’s credit record. Then, if approved, the lender sets a limit on how much can be borrowed. Then, the business can use as much or as little of that amount as they need. A primary difference between a business line of credit and a business credit card is the interest rate.
OVERVIEW
When a business needs cash but has a variety of cash needs from month to month, a line of credit is often the best solution. If a borrower gets funding from a traditional loan, but then discovers they don’t need the full amount, their interest rates are still calculated based on the total amount of the loan, meaning you will pay for funds your business doesn’t really need. Some traditional loans come with penalties for paying the excess portion back early.
If that borrower finds instead that they needed more funds than they asked for, they may have to take out an additional loan to satisfy their financial needs. That can eat into margins in the future because repayments and fees are due from two loans instead of one.
A line of credit eliminates both problems. Because the borrower can borrow and borrow again, they can take care of recurring expenses. Interest rates are applied only to the balance of funds withdrawn. Even if approved for a high credit limit, the borrower can take out a lower amount and avoid the costs of a fixed loan. If business is slow during one part of the year, money can be borrowed from the credit line. When business picks back up again, the credit line can be paid down. When the slow period comes around again, money has been freed up and can be borrowed again.
Lines come in two forms: secured and unsecured. An unsecured line is more difficult to qualify for and will require more documentation during the approval process. A secured line uses collateral to mitigate lender risk.
LOAN HIGHLIGHTS
Lines of credit are typically approved for higher amounts than credit cards are.
Credit cards usually carry higher fees and APRs than lines of credit.
Private individuals rarely seek credit lines unless they’re making a home purchase.
Payments can be made regularly to free up more cash for the future.
PROS
- Lines of credit are more flexible than most other types of loans.
- These loans make it easier to plan because the costs of projects can be unpredictable.
- Cash can be borrowed more than once.
CONS
- It may be difficult to qualify for a line of credit without a good credit history.
- The interest paid on a line of credit may not be tax-deductible.
- Because the balance can vary, it may be difficult to calculate interest payments.