How Do Business Lines of Credit Work?

Surprises happen—it’s a fact of life.

But how can you expect the unexpected when it comes to your business? A single accident could set you back a long way if you’re not prepared.

That’s why flexible business financing is so important.

And BCO helps thousands of small business owners get that funding in the form of a business line of credit.

Let’s learn more about how a business line of credit can help you weather storms and take advantage of unforeseen opportunities.

 

Business Lines of Credit: A Flexible Financing Option

What exactly is a business line of credit?

Simply put, a business line of credit is pretty similar to a personal line of credit (like your credit card).

A bank or lender gives you access to a specific amount of financing, which you can draw from whenever you want or need.

However, you don’t make payments or incur any interest until you actually tap into those funds. You pay for what you use, in other words.

 

An Example of “Revolving” Business Credit

Business lines of credit can come secured—backed by collateral like inventory, accounts receivable, and so on—or unsecured, backed by your personal guarantee.

This sort of financing often gets referred to as “revolving” credit because you can tap into it again and again… And when you repay what you’ve spent, you can take out even more.

For instance, say you’re given access to a $60,000 small business line of credit.

Next, 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 whole $60,000 at your fingertips again—without having to apply for another loan.

The time and energy you save is one of the biggest benefits to a business line of credit.

 

Business Lines of Credit vs. Traditional Term Loans

So what sets a business line of credit apart from a traditional term loan?

To start with, business lines of credit usually come with lower interest rates and closing costs than traditional term loans of similar sizes.

But on the other hand, if you’re late with a payment or go over your credit limit, that interest rate could spike pretty high.

Also, traditional term loans have regular interest rates over the life of the loan, which is a major difference between term loans and business lines of credit.

If you’re comparing a business line of credit with a traditional 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. But that doesn’t mean you can’t or shouldn’t use a business line of credit for business purchases, too.

 

Different Kinds of Business Lines of Credit

Though it’s not an industry standard, we split business lines of credit up into short-term and medium-term.

Why?

Although business lines of credit don’t really have term lengths—you can withdraw and pay back those funds indefinitely, as long as your lender believes that you’re a responsible borrower—these labels help you compare short-term loans with short-term lines of credit and traditional term (or “medium-term”) loans with medium-term lines of credit.

The differences are mostly in their minimum qualifications, maximum fund amounts, and interest rates.

 

How a Business Line of Credit Can Help You

The bottom line?

The biggest advantage of a business line of credit is its renewability: you can draw out funds, pay them back, and draw again.

You can use a small business line of credit to help finance ongoing operating expenses, cover cash flow gaps, take advantage of unexpected opportunities, and provide a cushion to protect against emergencies.

Since lines of credit are so flexible, they can also be used for payroll, seasonal expenses, and unforeseen problems or investments, as well as larger purchases.

This flexibility is what makes a business line of credit such a valuable loan product for small business owners.

 

Business Line of Credit vs. Credit Card

Although business lines of credit and credit cards are both forms of “revolving” credit, there are a few important differences you should be aware of:

1. Credit cards usually have higher interest rates.

2. Credit cards charge additional fees for cash advances and, often, balance transfers.

3. Credit cards typically require payments on a monthly basis while business lines of credit usually don’t.

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