What is a Business Line of Credit?
A business line of credit is somewhat similar to a credit card, in that the borrower is approved for a certain amount of money and can draw against that amount until they reach their credit limit. Like a credit card, the borrower is not required to make any payments until and unless there is an amount due. For example, a business owner might be approved for a $25,000 business line of credit with a 12% interest rate. The owner waits three months to make any withdrawals, and during that time owes no monthly payments. Once the business owner decides to make a withdrawal, let’s say $10,000 for a new piece of equipment, payments are due for a monthly “chunk” of the amount borrowed plus interest. Repayment terms can vary, but 12 months is a good rule of thumb, which means that the $10,000 must be repaid over that time period plus interest. This makes lines of credit more flexible than small business loans, since funds aren’t disbursed in a lump sum and payments aren’t required until an amount is borrowed.
If the business owner needs more cash while repaying the first portion of their withdrawal, they still have another $15,000 available to them from their line of credit. Just like with a credit card, the business owner can continue to receive funds until they reach that $25,000 limit. Also like credit cards, business lines of credit are typically classified as revolving debt, which means that the borrower can tap into the funds multiple times, assuming they’ve paid back what was originally borrowed.
Lenders’ policies vary, but the ability to withdraw funds from a business line of credit is usually relatively painless and fast. Some lenders with stricter policies in place may require the borrower to reapply for financing each time they draw from the business line of credit, to ensure that their creditworthiness has not changed.
Understanding business financing options is an important way to start and sustain growth. There are many lending products outside of traditional loans, so how can you be sure you’re shopping for the right thing? You’ve heard of credit cards, which work for businesses as well, but what about lines of credit? Business lines of credit may provide the working capital you need with less hassle than a credit card and more flexibility than a traditional small business loan.
Business Line of Credit Vs Business Loan
Business lines of credit are similar to business loans, in that they both provide funding for purchases, business growth, and other purposes. Both lending products require the small business owner to apply and be approved by the lender, and there are typically several conditions that have to be met before receiving any money.
Unlike business term loans, small business lines of credit are not usually tied to collateral and are not required to be used for a specific purpose. When receiving a business loan, the borrower typically provides collateral or uses the loan to purchase a specific item that is then considered collateral for the loan. Lines of credit are different, because the lender approves a borrower for a dollar amount that is not tied to any specific purchase. This makes lines of credit more convenient and sometimes more appealing, especially for short-term cash needs. The extra freedom of unsecured lines of credit may also mean that the lender has stricter policies surrounding lines of credit since there is very little securing the loan other than the borrower’s good credit.
How to Get a Business Line of Credit
Before applying for a line of credit, a business owner should make sure that they have their financial ducks in a row. Just like with regular loans, business owners will be expected to have income statement, tax documents, and personal credit information ready for their line of credit application. Lenders may also require a personal guarantee from the business owner, but the requirements will vary from lender to lender.
Applying for a Business Line of Credit
All lenders are different, but you can expect to fill out an in-depth application that covers at least the business’ financial background and in some cases the business owner’s personal credit background. Common documentation requirements include:
- Proof of having been in business for a set period of time (sometimes six months or more)
- Proof of annual revenues. Some lenders require $25,000 or more in sales before issuing a line of credit
- Bank statements
- Business tax ID and Employee Identification Number (EIN)
- Business owner/borrower’s social security number
- Business owner/borrower’s driver’s license
- Tax returns
- Business license
Completing the application with a high level of attention to detail and a commitment to having all of the correct information is key. All applicants should have their documentation ready at the time of application to avoid any delays in processing. If there are multiple applicants, it is important for everyone to understand that their personal credit scores play a role in the application process.
How Big of a Line of Credit Do You Need?
Unlike a traditional loan, you won’t be making monthly payment on a line of credit as soon as you’re approved. Other than overspending, which depends completely on the borrower’s sense of business and financial control, there is little downside to accepting a line of credit for the full amount that is approved. A larger credit line may actually prove to be a useful tool for building credit, because the level of credit utilization can remain low and the borrower can establish a pattern of making payments on time.
Borrowers won’t generally apply for a specific dollar amount for lines of credit, but it’s not out of the question to request the amount needed. In the same vein, lines of credit aren’t designed to function like loans, so regularly drawing the maximum approved amount is somewhat uncommon.
What If You’re Denied?
There are a variety of reasons that you weren’t approved for a business line of credit, and not all of them are bad. Some of the most common denial reasons include:
·Poor credit: If you or your business have had a rocky financial past, you may have a hard time getting a line of credit. Since there is no collateral and credit lines are not typically secured, lenders may be less likely to loan
- Low revenues: If your business is just starting out, you may not have built up the revenues that are required to obtain a business line of credit. If you are denied for this reason, you may not be the best candidate for a credit line until business and cash flow improves. It’s important to note that having a new business is not a “bad” reason for being denied
- Existing credit: Just like traditional loans, lenders are weary of borrowers with high levels of credit utilization and/or other existing lines of credit. You may also have trouble getting approved for a business line of credit if you have several other loans
- Incomplete or incorrect application: Lenders are under strict requirements from the government and other regulating bodies to maintain the highest level of accuracy and responsibility when it comes to approving loans. As a result, they are dedicated to receiving complete applications that accurately depict the borrower’s state of affairs. If you are missing paperwork or have incorrect information, work with your lender to complete or correct your application
Now that you know why you might have been denied, it’s important to understand what to do about it. First, don’t panic. It’s easy to see that there are several reasons you could have been denied, so the solution may be a relatively easy one.
Review Denial With Your Lender
Lenders are required to disclose denial reasons, and a good one will review them with you after the fact. Ask your lender about red flags or other problems that may have been spotted along the way so that you understand what to change or fix going forward.
Assuming that your denial was related to a specific problem with your application, you can go back to the drawing board to make updates and fix any problems that you identify. The application process may also uncover incorrect or old information on your credit report, tax documents, or other paperwork that requires your attention before reapplying.
If your application was denied for business-related reasons, your best remedy is to work on the deficiencies identified by your lender. You can work to improve your business credit score by making existing payments on time and by working to resolve any bad information on your credit report. You can focus on improving your business’ revenues and work on your accounts receivable to collect outstanding payments
Just because business lines of credit don’t always require collateral doesn’t mean that having collateral is a bad thing. If you’re serious about getting the credit line and have been denied, presenting collateral may help your case and show the lender that their money will be responsibly paid back.
Alternative Funding Options
Though you’ll pay a premium interest rate for the privilege, business credit cards can patch financial holes the same way that a line of credit can. Many cards have promotional rates, special financing discounts, and other incentives to draw in business, so it’s important to look at all the fine print before signing up for a new card.
Online lenders are not held as strictly to lending regulations as traditional banks and credit unions are, which may work in the borrowers favor to be approved with a lower rate or higher line amount. Several online lenders offer credit lines in the same amounts that their brick-and-mortar counterparts do, and many can have funds in the borrower’s bank account within just days of approval. Traditional lenders are perfectly fine ad may even be more convenient if the business owner holds checking accounts or other financial services with the institution.