What is a line of credit?


Lack of capital and liquidity remains a major concern for most small businesses. In fact, it ranked number one on the list of top challenges facing small business owners in the Guidant Financial rankings. Small Business Trends 2020 investigation. Many small business owners turn to a business line of credit to meet their financing needs.

What is a line of credit?

A line of credit is a way for businesses and individuals to borrow the funds they need to make purchases and pay bills or other expenses, such as employee salaries. A line of credit from a business credit card can also be used as a cash advance.

All lines of credit have a limit set by the bank, credit union, or other financial entity that provides them. The limit is flexible and the bank may be willing to increase it, depending on factors such as the financial health of your business and whether you make scheduled repayments on time.

A line of credit can be either secured – that is, backed by collateral such as a building or house – or unsecured. With this type of financing, you only pay back what you borrow, plus the interest on the credit you have used. This is the main difference between a line of credit and a small business loan. [Read related article: Unsecured vs. Secured Business Loans]

What are the different types of lines of credit?

Lines of credit fall into the following four categories.

1. Business line of credit

You are more likely to get a business line of credit if your organization has a positive payment and credit history and can demonstrate that it has the income to repay the money. This type of financing gives you access to funds for all expenses related to the business.

Some lenders who provide lines of credit require that a business asset, such as an office building or machinery, serve as collateral for the line. Secured commercial lines of credit generally bear lower interest rates than unsecured lines.

2. Business credit card with revolving line of credit

A business credit card can be the place to start if your business is new and cannot yet meet the requirements for a bank’s business line of credit.

In addition to letting you charge for purchases up to a certain limit, a business credit card usually gives you the option of taking a cash advance. However, some cards have lower cash advance limits than the usual line of credit on the card.

3. Personal line of credit

This type of funding provides access to funds for personal use. Some people open a personal line of credit for emergencies. Others do it for a specific purpose, such as buying a house, paying for a marriage, or financing a child’s education. A personal line of credit may or may not be secured.

4. Home Equity Line of Credit (HELOC)

Homeowners who have accumulated equity in their property may be eligible for this type of financing.

Equity is the difference between the market value of the home and any liens or mortgages currently outstanding on it. For example, if your house is worth $ 400,000 and your current mortgage is $ 250,000, the equity in that house is $ 150,000.

Homeowners use HELOCs for a variety of purposes, such as remodeling or renovating a home, financing a child’s college education, buying a car, or buying a second home or home. another real estate. Some people turn to a HELOC when they need to pay off credit card debt or other personal loans.

How does a revolving line of credit work on a business credit card?

A revolving line of credit on a business credit card is constantly “renewing” itself. As you pay off or pay off your outstanding balance, your line of credit increases up to the limit set by the bank that issued it.

For example, suppose you open a business credit card account with a revolving line of credit of $ 25,000. A few days later, you use it to purchase $ 3,000 of supplies for your business, leaving $ 22,000 available. If you paid the bill in full the next month, your available credit line on the card would again be $ 25,000. If you paid it in monthly increments, your funds available for purchases or cash advances would increase by that amount to reach $ 25,000.

Your bank will charge interest on your outstanding balance. According to US News, the Average Annual Rate (APR) on Business Credit Cards ranges from 14.22% to 22.18%.

If you take out a cash advance, you’ll pay a higher APR plus a cash advance fee, which can be either a percentage of the funds advanced (typically 2% to 5%) or a fixed fee (typically $ 10 to $ 15), which is the most money.

What are the differences between a business credit card and a business line of credit?

A business credit card and a business line of credit might sound similar, but keep in mind these four differences between the two.

1. Funding limits

The credit available on a business credit card generally does not exceed $ 50,000. With a business line of credit, this can be as high as $ 250,000.

2. Cost of cash advances

Card-issuing banks charge a higher fee and interest rate for cash advances than what you pay when you use the card to make purchases. These higher rates and fees are irrelevant when choosing a business line of credit.

3. Repayment flexibility

A business credit card offers a flexible repayment schedule, allowing you to choose how much of your balance you pay off each month, while a business line of credit has a fixed end date and a fixed repayment schedule ranging from six. months to three years.

4. Trade-off between fees and rewards

Most banks have a business credit card rewards program. The tradeoff is that most business credit cards have an annual fee, which covers the cost of the benefits offered by the bank as part of the program.

In contrast, a business line of credit doesn’t come with any rewards, but it doesn’t come with an annual fee either.

When should you use a revolving line of credit on a business credit card?

According to Michael Hammelburger, CEO of Expense reduction group.

A business credit card also works well in the event of an emergency that you don’t have the cash reserves to cover. For example, if the vehicle you drive on business needs repair after an accident but you can’t wait for insurance payment to get the job done, a business credit card would be a convenient way to pay for that expense.

Hammelburger said a business credit card was not the right option for refinancing existing debt, buying real estate, or making any other type of large investment. A small business loan or a business line of credit is a better bet here, mainly because it usually offers more money than what is available on your business credit card.

Brian Cairns, Founder of ProStrategix Consulting, agreed, adding that a business credit card shouldn’t be your first choice for financing your business because even the best credit cards have high interest rates. It is possible to occasionally deposit such a card for an expensive item when finances are tight, but only if you can repay that item quickly.

Hammelburger also advised against paying personal expenses with a business credit card. “If you do this, it’s hard to separate business expenses from personal expenses at tax time, and I’ve seen it become a real nightmare. If you make a mistake, it could be a red flag for someone. audit.”

What other financing options are there for small businesses?

In addition to a business line of credit or a business credit card with a revolving line of credit, you might want to consider a small business loan. Here are some of the differences between a business credit card and a small business loan.

1. Application process

Qualifying for a business credit card is faster and easier than getting approved for a small business loan application. Loan applications are more complex because banks want assurance that your business will be able to pay them back. Typically, they look for a good debt-to-income ratio (with minimal existing debt) and a minimum two-year history in business, among other qualifications.

2. Convenience and flexibility

Accessing the funds for a small business loan often takes several weeks. You receive the lump sum up front, whether or not you need the funds in full, and pay interest on the full loan amount.

With a business credit card in hand, you can immediately charge your purchases or access cash, and you only pay back what you’ve borrowed (with interest, if applicable).

3. Rewards and incentives

Depending on the issuing bank, you may receive a signup bonus or earn airline miles, shopping discounts, restaurant discounts, or other perks for using your business credit card. You can also earn money on the purchases you make with the card. Business loans do not come with these incentives.

4. Cost of borrowing

Interest rates on business credit cards are typically much higher than interest rates on small business loans or a bank’s fixed lines of credit. These rates can increase over time, and interest accumulates very quickly if you don’t pay your bill on time and in full each month. Plus, inadvertently going over your credit limit or paying your bill late can result in fees and penalties that put a strain on your business.

Business loans have lower interest rates, but again, you pay them for the full loan amount.


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