What Is a Business Line of Credit and How Does it Work?

Here are the basics of getting a business line of credit.

Capital can finance your business operations, but it’s not always clear where to get business credit. Perhaps you’ve searched for everything from payday loans to personal loans and bad business credit loans, plus everything in between, for a solution.

Many business owners overlook a business line of credit product for small business startup loans, SBA loans or small business grants. This type of bank loan can be a more flexible option for business owners who need constant access to credit without the inconvenience of lower credit limits and the reapplication process required for a term loan.

Here’s an overview of how and where to get credit for your business.

How Does a Business Line of Credit Work?

Unlike a term loan, which is a lump sum of money with fixed payments and amortization schedule, a business line of credit provides the money you can borrow on an ongoing basis. Much like a credit card, you can use the amount of credit that you need, then only pay for what you use.

The advantage here is that you will only pay interest on the amount of credit you are actually using. If your business line of credit limit is $20,000, yet you are only using $5,000, that’s the amount you’ll be charged interest on and what you need to pay off. Once it’s paid off, you have access to the full $20,000 in credit again.

Check Out: 7 Surprising Costs That Come With Starting a Business

When to Get a Business Line of Credit

A business line of credit is a secured or unsecured line of credit used for business purposes. It’s ideal for entrepreneurs who will have recurring needs for business credit, but don’t necessarily want to take on a term loan.

With a term loan, you’d have to make payments (with interest) on debt each month — even if you aren’t actively using it or have an immediate need for it.

This can be expensive for many business owners. A business line of credit can also be a better alternative to business credit cards. The annual percentage rate (APR) for business credit cards tends to be high, and the credit limit might be lower than the amount of credit you need access to.

You would use a business line of credit if neither a term loan nor business credit card met your business credit needs. It’s a good solution for seasonal businesses or companies that often have a surge of activity that requires urgent access to short-term loans with flexible terms offered by a line a credit.

Related: 7 Best Business Lines of Credit 

Key Terms and Conditions

You should know about the fine print when it comes to securing a business line of credit. For starters, there is usually an annual fee. The bank’s annual fee will depend on your credit limit and might be waived for higher credit limits.

Interest rates and APRs on business lines of credit are variable. Instead of knowing what your APR is at the outset of the loan, your rate can reset and change based on prevailing interest rates.

In order to qualify for a business line of credit, the bank might want to see that your business is established, profitable and has a consistent history of stable, predictable income. If this doesn’t describe your business situation, then a business credit card might work better for you until your business is more established.

Pro and Cons of a Business Line of Credit

Before applying for a business line of credit, you should know both the pros and cons of this type of bank loan.

Pros:

  • Only pay for what you use
  • Apply once and reuse as needed
  • Credit limits up to $500,000
  • Manageable monthly payment for lower balances
  • Can be used as overdraft protection
  • Cash advance fees can be lower or waived entirely

Cons:

  • Might have an annual fee
  • Might require assets as collateral
  • Variable interest rate
  • Might need to have an established business and business income history to qualify
  • The bank reserves the right to reduce or call lines of credit in early

Up Next: These Are Some of the Least Expensive Businesses You Can Start

A business line of credit is ideal for covering temporary gaps in cash flow but do your homework. Being confident starts with being informed.