What Is a Line of Credit?
A line of credit (LOC) for a small business is an extremely flexible type of business loan that allows you to withdraw funds as you need them and only pay interest on what you borrow. You must pay at least the minimum monthly payment, or you can repay any amount over that minimum. And as soon as you repay an amount on the loan, that same amount immediately becomes available to borrow again. In this way, it is very much like a credit card. Credit lines are especially beneficial when profits are low, unexpected costs occur, or your business has an opportunity to suddenly expand and quick cash is needed. Or you might simply just need it to pay payroll or rent during a slow period.
How Is an LOC Different from a Term Loan?
A term loan is a lump sum of money you receive all at once, whereas with a line of credit, you only borrow small amounts of money at a time. With a term loan, you are set up to repay the full amount of that loan through equal incremental payments over a fixed period of time (term). Whether or not you use any of the money, you still must make monthly payments, dictated by the rate terms of the loan, until the loan is paid off.
Another major difference between an LOC and a term loan is the loan amounts and the repayment timeframe. A term loan is often up to $600,000 with a repayment schedule up to five years. However, a business line of credit is usually only up to $250,000 for up to two years. A credit line usually has higher interest rates with lower minimum monthly payments than those for loans.
How Do I Get a Line of Credit for My Business?
First of all, you must qualify for a line of credit. Most lenders want your business to have been in operation for at least three years while maintaining a steady income. Depending on the size of your line of credit, you may need to offer collateral such as equipment, property, etc., that the lender can seize if you don’t make your payments. You may find that some online lenders will offer less stringent qualifications than traditional lenders like banks and credit unions, but you will also find they charge higher rates than the traditional lenders.
Find out from your lender what they require such as bank statements, tax returns, balance sheets, financial statements, and any other documentation needed to process your line of credit quickly and properly. It’s also a good idea to ask your lender about any other necessary qualifications. Typically, these include time in business (2 years for banks and at least 6 months for online lenders), annual revenue (annual income of $250,000+ for banks and $50,000+ for online lenders), and minimum credit score (banks like at least 680 – online lenders want a score of 500+). Gathering this information early can help you prepare well in advance and improve your qualifications before trying to get the line of credit.