Understanding Business Lines of Credit
Starting a business or expanding on your current one will likely require assets that many business owners acquire through either a loan or a business line of credit. Understanding lines of credit for your business can help you make better financial decisions and keep your future secure.
What Is a Business Line of Credit?
A line of credit provides funds when a business owner needs them that are paid back over time. Since businesses often have both start-up and continuous maintenance costs, lines of credit are a flexible alternative to a typical term business loan.
Line of Credit Versus Term Loan
Traditional term loans provide upfront funds that are taken in a lump sum and then used in whatever business capacity they are needed. Funds obtained from a term loan are paid back under specific term conditions in agreed-upon increments. In contrast, funds from lines of credit are withdrawn on an as-needed basis and are then paid back as they are used. Although both methods involve paying interest in addition to the balance, a line of credit does not require all of the money to be borrowed at one time.
Types of Lines of Credit
Similar to traditional term loans, a line of credit can be either secured or unsecured. A secured line of credit requires the use of the property or a deposit as collateral. Secured credit lines can be appealing to some business owners because they do not involve the stringent requirements needed for an unsecured credit line. Since the lender of an unsecured line does not have collateral to use if you default on your payments, you typically need to prove financial stability through excellent credit scores and documented business success.
If approved for an unsecured line, there are still some notable differences when compared to secured lines since the lender is taking on a higher level of risk.
- Term lengths are usually shorter
- Interest rates are typically higher
- A maximum credit limit may be lower
Types of Collateral For a Secured Line of Credit
If you are considering a line of credit but don’t qualify for an unsecured line, you can use a variety of business-related sources as collateral. If you are using the credit line to pay for expensive equipment, that piece of equipment itself can be used as collateral. Similarly, you can use your valuable business inventory for credit collateral.
Understanding the different lending options can help you expand your business while keeping it financially secure.