A business line of credit gives access to a pool of funds to draw from when you need capital. It gives you the flexibility to borrow up to a set amount—typically anywhere from $50,000 to $500,000—whenever you need access to capital. You don’t make payments or incur interest until you actually tap into those funds.
You can draw on a small business line of credit to handle cash flow gaps, access more working capital, address an emergency, or take advantage of a business opportunity.
Lines of credit are similar to a credit card: A bank or lender approves you for a set amount of financing (similar to a credit limit) which you can draw from at your discretion.
Once you repay what you’ve spent, you can continue to draw capital from your line of credit. This sort of financing is often referred to as revolving credit because you can tap into it again and again.
Here’s an example: Say you’re approved for a small business line of credit of $60,000. You decide to take out $40,000, keeping the other $20,000 in the pool of available funds.
Once you pay that $40,000 back, plus interest, you’ll have the full $60,000 at your fingertips again—without having to apply for another loan.
Revolving small business lines of credit typically don’t have term lengths—you can withdraw and pay back those funds indefinitely, as long as your lender believes that you’re a responsible borrower. The time and energy you save is one of the biggest benefits to a business line of credit.
Although most business lines of credit are traditional revolving credit products, some will not automatically renew after you’ve fully repaid what you owe. Some non-revolving lenders will have you reapply to renew your line of credit. Assuming you’ve remained in good graces with your lender, reapplying should be an easy process.
Business lines of credit are sometimes differentiated as short-term lines of credit and medium-term lines of credit. The differences are mostly in their minimum qualifications, maximum fund amounts, and interest rates.
The longest-term lines of credit typically come from a traditional bank. Medium-term lines of credit and short-term lines of credit are typically found with online lenders.
Business lines of credit can come secured—backed by collateral like inventory or accounts receivable—or unsecured, backed only by your personal guarantee.
So what sets a business line of credit apart from a traditional term loan?
To start, business lines of credit usually come with lower interest rates and closing costs than traditional term loans of similar sizes. But if you’re late with a payment or go over your credit limit, that interest rate could spike pretty high.
Also, with term loans, you pay interest constantly for the entire repayment period, whereas with lines of credit, you only pay interest on the amount of money you draw, when you draw from the line.
If you’re comparing a small business line of credit vs. a term loan, keep in mind that lines of credit tend to work better for repeated cash flow issues while term loans often make more sense when it comes to specific purchases or one-off business investments. But that doesn’t mean you can’t or shouldn’t use a business line of credit for business purchases, too.
Although business lines of credit and business credit cards are both forms of “revolving” credit, there are a few important differences you should be aware of:
The biggest advantage of a business line of credit is its renewability: you can draw funds, pay them back, and draw again.
You can use a small business line of credit for a variety of business purposes, including the following:
This flexibility is what makes a business line of credit such a valuable loan product for small business owners. If something unexpected happens, you have the money on hand to be able to deal with it.
Younger, less established businesses might be able to qualify for short-term lines of credit, while medium-term lines of credit are more for businesses with good credit and a solid financial history.
The maximum amount of funding available, introductory duration of the credit line, and repayment terms depend on your business’s revenues, credit rating, history, and other factors.
Applying for a business line of credit can be a relatively easy process, depending on the lender you’re working with.
Online business line of credit providers have quick, streamlined applications, thanks to the use of technology in their underwriting processes. These providers typically offer smaller, shorter-term options.
Traditional banks, on the other hand, have more intensive applications and may take slightly longer to fund, but offer larger and longer-term lines of credit.
With banks, you may also need to provide the following:
The basic cost of a business line of credit is pretty straightforward: You only pay interest on the cash you draw.
Say you have a $25,000 line of credit and use $5,000 from that line of credit to cover your debts while you wait for payment from a customer. If your interest rate is 11%, you’ll pay back $5,550 (or $5,000 plus $550 in interest).
Once that’s paid off, you can continue making additional draws up to the $25,000 maximum, only paying interest on what you’re borrowing at any given time.
A business line of credit is among the most flexible financing options out there. Even if you don’t have any immediate financing needs, having a line of credit as a rainy day fund can provide you with peace of mind. What’s more, if you pay back what you use quickly, the cost of a line of credit can be relatively inexpensive. For all these reasons, we recommend a line of credit for any business owner that has short to medium-term financing needs.