What are the advantages of a business line of credit over a traditional term loan?
Most entrepreneurs at one point or another will seek need financial help to launch their business, get through a rough patch, or expand. Traditional bank loans can provide funding for purchasing equipment, ramping up for the holiday season or simply covering payroll.
Borrowers can obtain small business loans from traditional sources, such as banks and credit unions, as well as online marketplace lending platforms that connect them with institutional investors and other sources of finance. Lenders will require information including P&L statements, two or three years’ worth of business tax statements (for existing businesses), and a well-written business plan that details the goals and objectives of the company and how they will be achieved. Lenders will also look at credit reports and individual tax returns.
With a traditional bank loan, the borrower specifies the amount required, and if the loan is approved, the amount requested is given in a check or a deposit into the borrower’s bank account. The repayment interest rates and the length of time the borrower has to repay are spelled out in the loan documents. Usually, loans are repaid in monthly installments at amounts that depend on the full amount of the loan.
A business line of credit works differently. This type of funding frequently is used to help business owners manage cash flow, pay for inventory or cover unexpected expenses. Essentially, a line of credit is like having a debit account. A large amount of money is available for use by a company to draw against in times of need. The borrower can use some or all of the money, and then pays interest only on the portion that has been used. For example, if a company has a $25,000 line of credit line but uses just $10,000 of it, the interest is paid on the $10,000, not the full $25,000.
Companies will tap into a line of credit for equipment, vehicles, inventory and hiring and training workers as businesses ramp up for new projects. Opening a line of credit enables businesses to access financing when it is needed. It provides flexibility.
SBA loans often have the lowest rates of interest. Currently, loans of $50,000 or more can be obtained at rates as low as 6.5 percent. Rates for smaller loans are a little bit higher, typically at rates of 7.5 to 8.5 percent. CDC/504 loans, designed to help minority and women entrepreneurs and to spur economic activity in disadvantaged communities, can be obtained at rates of about 4.5 percent.
Interest rates on a business line of credit vary. Currently, lines of credit can range from 7 percent on the low end and 20 percent or more on the high end. The rates depend on a borrower’s credit history and other factors. Lines of credit, which can range from $10,000 to up to $1 million or more, can often be obtained in a short amount of time – sometimes in a day.