7 Things to Know About a Business Line of Credit

A business line of credit is one way you can borrow money to grow your business. But you may want to consider some important facts before you make use of this financial tool.
May 11, 2018

Does your business have a temporary cash-flow problem? Do you want to pursue a time-sensitive, revenue-generating opportunity? Opening a business line of credit may give you a little extra cash to draw from when the need arises.

One of the top advantages of a business line of credit is that it can help ease the payment of interest charges on the money you borrow. That's because you don't pay interest charges until you need to use the money.

Let's say your business line of credit is for $50,000, but you only draw $20,000 to buy new equipment. You would pay interest only on the $20,000 that you borrowed, even though the other $30,000 is at your disposal should you need to draw it later.

If you decide to take advantage of a business line of credit, it pays to know a few facts. The following may help you avoid potential problems down the line.

1. Know the difference between a secured and unsecured line of credit.

You have the option of choosing a secured or unsecured line of credit. A secured line of credit means that the amount you borrow is secured through assets that belong to your company. In the event of payment default, the lender assumes the ownership of these assets.

With an unsecured line of credit, on the other hand, there are no specified assets required as collateral against the funds you borrow.

With lines of credit, one size doesn't fit all. Do your homework to avoid surprises.

One advantage of a secured business line of credit is that you may qualify for access to a larger sum of money because the line of credit is backed by your assets. The interest rate could also be lower.

On the other hand, one of the advantages of an unsecured business line of credit is that you can have access to the funds faster. That's because the application process is usually simpler, but you're likely to pay a higher interest rate.

2. Pay attention to potential fees.

In addition to your interest charges and the repayment of the withdrawals, you're also likely to be charged transaction fees every time you borrow from your line of credit. If you access your business line of credit several times during the year, these fees can add up.

Depending on your lending institution, you may also be charged a maintenance fee for your account even if you don't use it. Check out all the fine print related to fees so that you're not caught off guard.

3. Be aware of potential bank drawdowns on an existing business line of credit.

During times of economic uncertainty, the lending institution might demand that you pay back the balance on your line of credit at their discretion. Be aware of this particular provision if it's a part of your agreement with the lending institution.

Ask yourself what you would do in this situation. If you can't afford to repay the loan on short notice, a business line of credit may hurt your company's financial situation.

4. Be prepared for interest-rate variability.

Typically, the interest rate on a line of credit is variable. It's based on a percentage above or below the prime lending rate.

If interest rates increase, you may find it difficult to pay back your line of credit. With the relative ease of borrowing money through a line of credit, you may find that you're exercising less control in your spending. And with interest rate increases, this could result in financial hardship as your debt increases.

5. Look into insuring your business line of credit.

You might want to look into the possibility of buying insurance to cover a business line of credit.

Insurance can help you cover outstanding payments on your business line of credit in the event of critical illness, injury or death. Depending on the size of your line of credit, this could be vital protection for you and key members of your company.

6. Know the criteria for evaluating the best line of credit.

With the wide array of lending institutions offering a business line of credit, it may be difficult to choose the right option. Interest rates vary from lender to lender so you may want to focus on this aspect as one of the primary considerations.

Next, look at what the borrowing limits are to make sure that there's sufficient credit to meet your future needs.

You may also want to evaluate the repayment terms to ensure they fit your requirements. Repayment terms vary greatly, ranging from weekly to monthly repayments. With lines of credit, one size doesn't fit all. Do your homework to avoid surprises.

7. Consider the help available from the Small Business Administration.

The Small Business Administration offers a plan that's designed to help small-business owners obtain a line of credit.

While they don't lend you money directly, their program can make it easier for you to access capital. One way they do this is through their Lender Match program, which matches you with lenders that express interest in lending you money. This could make the whole process of obtaining a line of credit easier.

Read more articles on financing.

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