For many of the estimated 33.2 million small businesses operating in the U.S., finding ways to grow and expand is challenging. Many companies have limited or uneven cash flow. While sustaining operations may be simple enough, reduced access to funds at critical moments could make seizing opportunities difficult, stymying a small business’s ability to grow. As a result, many consider getting a business line of credit to increase their access to funds.
Business Line of Credit Definition
A business line of credit is a financial product that operates similarly to a credit card. Once approved, a small business is assigned a borrowing limit representing the maximum amount of money it can borrow. Unlike a small business loan, the funds aren’t given as a lump sum. Instead, companies can use any or all of the credit line at their discretion.
Once the small business borrows money from the credit line, it will owe monthly payments to cover the borrowed principal and any interest. Interest rates can vary, often ranging from 8% to 60%, though some may come with higher APRs.
Key Characteristics of Business Lines of Credit
Generally, the key characteristic of a business line of credit is that it’s a revolving account, not unlike a credit card. After borrowing a sum, monthly payments are required. After each payment — suggesting no more is borrowed — the principal shrinks.
Small businesses can effectively re-borrow money as the principal gets paid down. For example, if the credit line is for $10,000 and the company uses $9,500, its remaining borrowing power is $500. However, if the small business makes a payment that reduces the principal by $500 – making the current amount owed as principal $9,000 – it then has the ability to borrow up to $1,000 based on the remaining credit line.
Additionally, interest is only calculated based on the current amount borrowed, not the full value of the credit line. For instance, if the company has a $10,000 credit line but only uses $5,000 of it, interest is only calculated on the $5,000 that’s borrowed.
Classically, interest rates associated with business lines of credit are variable, not fixed. As a result, changes to the prime rate – which is managed by the Federal Reserve – can cause the associated APR to increase or decrease, usually based on shifting economic factors.
What Can You Use It For?
Generally, companies can use a business line of credit for any legitimate business-related financial need. That includes ongoing operating expenses like supplies, payroll, and inventory. Additionally, small businesses can use the funds for equipment purchases, upgrades, repairs, or maintenance.
Usually, the only restriction on a business line of credit is that the funds can only support the company. Using a business line of credit for personal purchases or expenses isn’t permitted.
Tips for Choosing a Lender
If you’re interested in a business line of credit, you want to choose your lender carefully. Along with examining the available interest rates, consider the lender’s reputation, particularly when it comes to customer service. Additionally, look at the repayment terms and the company’s fee structure, as those both significantly impact your overall experience.
