There are different types of financing that you can obtain as a business owner. The most popular are a line of credit or a business loan. Which will work better for you will mostly depend on what it...
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When your company needs cash to cover impending expenses, you don’t have time to wade through the business loan application process. Having a line of credit for your business in place provides access to a guaranteed amount of money any time you need it so that you never find yourself in a financial bind.
If you routinely require small amounts of money to keep your business going rather than large lump sums for occasional expensive purchases, a business line of credit could be right for you.
There are many types of business loans, but a line of credit is somewhat different. The choice between applying for a business loan or a line of credit loan depends on how much cash you need and what you intend to use it for. Business loans typically:
Provide one-time lump sum payments
Require repayment at a fixed interest rate
Have stable, predictable monthly payments
Include closing costs or early repayment penalties
Lines of credit, on the other hand, are similar to credit cards in the way the money is accessed. If you qualify for this type of loan, you can expect:
A set amount of money to borrow against
Flexibility to borrow as much as you need at any time
Monthly payments calculated based on how much was borrowed
Variable interest rates lower than the prime rate
A draw fee for borrowing against the credit line
Few or no closing costs
Both loan types require good cash flow, a solid credit score, and a strong financial standing.
Certain businesses, such as retail establishments, benefit more from lines of credit because of the predictable variations in cash flow. Seasonal changes in sales mean earnings fluctuate on a set schedule, and extra money is often needed to continue operations during slow times. When you’re able to anticipate these financial needs, you can rely on a line of credit to provide security.
A line of credit is also useful when:
You require a short-term boost in working capital
You’re unable to meet a payroll deadline Inventory needs to be increased or replenished
You need to cover expenses associated with hiring new employees
Marketing efforts need to be increased in anticipation of a special event
These types of expenses may not be specific or concrete enough to allow you to qualify for a regular business loan. However, since line of credit loans are given based on financial standing rather than a specific spending plan, you can still get the funds your business requires.
Like a business loan, a line of credit may be secured or unsecured. Secured credit lines need collateral to back them up. Unsecured lines are guaranteed by your business and require more trust on the part of the lender. In both cases, you’re at risk of loss should you be unable to make payments. The lender will either take possession of your collateral or have the choice to sue you for what you owe.
To avoid these problems, work to build up a good credit score for your business and yourself. Have a dedicated business bank account, and stay on top of all your payments. Keep detailed records of cash flow, profit and loss, accounts payable and receivable, revenue streams, assets, and income. Most lenders will want to see this information when deciding whether or not to extend a line of credit to your business.
When applying, ask about any fees associated with the credit line. There may be fees for borrowing money or maintaining the account when you haven’t borrowed for a length of time. Make sure you understand the interest rate and the payment structure so that you can continue to practice good credit management.
You may wonder why it’s worth the effort to go through the application process for a line of credit when a credit card offers similar borrowing options. However, credit cards can hit you with fees and penalties subject to change with little warning. Interest on a line of credit is often lower, and making regular payments also builds up your credit rating.
When compared to some of the best business loan providers, the monthly payments on a credit line tend to be smaller, and you don’t have to worry about the money “running out” when you need it most. Instead, you have a set credit limit to draw from for the duration of the loan term. As long as you’re diligent about paying off what you borrow, you won’t be saddled with the specter of long-term debt.
Traditional brick and mortar banks are one source of funding for businesses, however, they may not always be a viable option for every business. Online lenders provide a simplified path to receiving a line of credit and often are willing to give funds to those who may not be approved by banks. In addition, online lenders often provide funds much quicker than traditional banks. When choosing a lender, or lending platform, to provide you with a business line of credit, there are several key factors to consider.
While traditional banks come with a reputation built in, you may not be as familiar with the leading online lenders. However, this does not mean that such lenders don't have reputations as solid as banks do—you simply have to do some research or check with the experts to make sure they have a track record of providing reliable service. Look for an A+ rating with the Better Business Bureau to ensure that the lender is worthy of your business.
2. Minimum Credit Requirements
Various lenders are willing to take on differing levels of risk. You can save yourself a lot of time if you know ahead of time what a lender's minimum credit requirements are. Online lenders are generally much more forgiving than banks in this regard, and are prepared to look at a number of factors other than credit score to determine your worthiness for a business line of credit. However, lenders will clearly state what their minimum requirements are, so if you don't meet these, you’ll know to look for another provider with more lenient approval standards.
3. Funding Amount Limits
Those seeking a business line of credit may not have a specific purchase they are funding with a set dollar amount, however they are still likely to have some idea of how much funding they need. Lenders generally have a minimum and maximum line of credit that they will give a business. If you are seeking more than $500,000, then a business line of credit is not the loan option for you. However, the leading online lenders will provide at least $100,000, with some of them extending far beyond this amount.
4. Funding Speed
The speed with which borrowers gain access to their funds is one of the main advantages that online lenders offer over banks. The approval process is often a matter of days and borrowers can start drawing off of their lines of credit in weeks, if not days.
5. APR and Fees
If you are a business owner, a line of credit is a product you purchase to serve your operation. Just as you would seek the product that gives you what you need for your business at the lowest possible price, you will want to choose the line of credit with the lowest APR. The APR, or annual percentage rate, takes into account how much the line of credit will cost you annually, including interest rate and any fees.
Read our in-depth review of Kabbage to find out more about this lender.
Read more about this lender in Fundbox’s in-depth review.
Our full-length review of Lendio provides more details about this great lender.
While this type of business loan may sound like the perfect fix for just about any cash flow problem, it’s easy to slip into bad habits or make poor judgment calls. To make a business credit line work for you, be careful not to fall victim to these financial mistakes:
Waiting until the last minute to apply
Not comparing rates, terms, and qualification requirements between lenders
Missing out on potential “upgrades” after improving your credit score
Neglecting to ask if the lender reserves the right to “call” the loan
Maxing out the credit line
It’s essential to be thorough when looking for a lender and careful when establishing a payment structure so that you don’t wind up in a tenuous financial situation.
With a business line of credit in place, you don’t have to worry about your company going under due to unexpected expenses or a particularly slow season. Be smart about how you use the money available to you, and your company will remain lucrative even during tough times.
If you’re looking to establish a line of credit or you’re wondering how to get a business loan, check out the chart above and take a look at some of the top lenders. Read through our detailed reviews, and make the right choice to ensure your business success.