How to manage a business line of credit

A business line of credit (LOC) can be a helpful alternative to a business term loan. Since most LOCs are a revolving type of credit, the lender lets you borrow up to a preset limit, repay the loan and then borrow that money again. Lines of credit are also quite popular. According to the 2023 Small Business Credit Survey by the Federal Reserve Banks, 43 percent of small businesses applied for business lines of credit, the highest rate of any credit type.

To maximize the benefits of a business credit line, you need to be strategic about withdrawals and account for related fees. Without understanding your interest rate and payment schedule, you could hurt your finances by taking on too much debt. You may also risk your future relationship with the lender if they notice you’re not handling your line of credit responsibly.

Why managing your business line of credit is important

A business line of credit can be a great tool for businesses, but you need to manage your credit well. While you could boost your business credit if the lender reports your timely payments to business credit bureaus, you could damage your credit score by paying late.

Paying on time could even help you build a case for getting a credit limit raise from your lender. Plus, managing your LOC well means you can keep it open and use it as a financial resource for emergency expenses.

Overspending and mismanagement can put you in debt that worsens as interest accumulates. In the end, it could even lead to bankruptcy, making it difficult to get future business loans.

5 tips to manage your business line of credit

Managing your small business line of credit starts with an understanding of the costs and how much debt you can afford to take on at any given time. Then, you simply need to make timely payments. Let’s dig into each area to help you manage your line of credit well.

1. Be strategic about withdrawals

A business line of credit differs from a term loan because you don’t get a one-time lump sum of cash. Instead, most lines of credit are reusable forms of credit that you can use repeatedly when needed. It works much like a business credit card: You must pay interest on borrowed funds. As you repay the balance, that amount is available to borrow again.

Businesses can use a line of credit to bolster cash flow during slow times. For example, if your business is seasonal, you could use your LOC to pay for operating costs like inventory while being cash-poor from outstanding invoices. Lines of credit can also act as a short-term loan, helping you pay for small expenses that you know you can pay off quickly.

However, you shouldn’t use your line of credit when you don’t need to. It might be better to look for efficiencies and cut back on spending — eliminating or reducing your need to borrow — rather than taking on debt.

2. Account for fees

While you don’t have to pay interest on a business credit line until you spend money, you may have to pay fees. Common line of credit fees may include:

• Origination fee: A one-time fee charged when you open the small business line of credit
• Maintenance fee: Monthly or annual fees for holding an account
• Inactivity fee: Fees that may be charged when you don’t draw funds from the account often enough
• Draw fee:A fee charged when you spend money from the account
• Renewal fee:A fee charged if you renew the LOC for an additional draw period

3. Understand your business line of credit interest rate

Typically, you start accruing interest on a LOC when you draw funds. To help you manage payments, know your interest rate and how much you’ll pay in interest when you decide to draw funds.

Let’s say you use $10,000 from your business credit line, and it has an interest rate of 10 percent. If you want to pay off the balance in one year, you’ll need to make a monthly payment of around $880. In total, you’ll pay about $550 in interest.

You can use a business loan calculator to figure out costs based on your repayment schedule. Here’s a breakdown of the total borrowing costs for this example, assuming a 12-month repayment term:

• $879.16 x 12 months = $10,549.92
• $10,549.92 (total loan cost) – $10,000 (original loan amount) = $549.92

4. Make on-time payments

To avoid late payment fees or even defaulting on a business loan, making your payments on time is vital to any business loan. On-time payments also build your business credit score, helping you secure future financing with favorable interest rates and repayment terms.

If you want to save money on interest, you can also make extra payments to pay down the balance. As you pay down the balance, interest gets calculated on the new lower principal amount. This leads to paying less in interest over time, though your regular payments will stay the same.

But paying quickly also means making higher payments. If your business is short on cash, that might not be possible. In this case, a better strategy for managing your credit line might be to make smaller payments and swallow the extra interest costs instead of emptying your pockets. Use your knowledge of your business’s cash flow patterns to set your strategy.

5. Ask to increase your business line of credit (if it makes sense)

Having the right line of credit for your business can help increase your business credit score if you make timely payments and manage your payments well. Another way to potentially increase your credit score is to ask for a credit line increase after the account has been open for at least a few months.

If your limit grows, but you keep the same spending habits, your credit utilization ratio will decrease — and a lower ratio may mean a higher credit score. A higher credit score could help you qualify for lower interest rates, though you may need to refinance in order to take advantage of lower interest rates.

Asking for a credit line increase is not always a good idea. It doesn’t make sense to increase your line of credit if you recently made any late payments on your account. The lender will be unlikely to say yes.

When not to use your business line of credit

If you’re continually losing money on operating costs, using your line of credit may not be the best option. Ongoing losses signal that you have a bigger problem than a business loan can fix. If you have a leaking ship, it’s better to patch the leak than keep bailing water.

You can start by taking a hard look at your business budget and seeing where you can adjust expenses. If you have an existing business loan or you’ve already drawn from your credit line, you could think about refinancing to a new loan. If you have multiple business loans, you’d look for a loan that you could use to consolidate your debts into one loan, preferably with lower interest rates.

To refinance or consolidate, you could either talk with your current lender or compare small business loans to find a lower interest rate than your current loan or a longer repayment term. Keep in mind that a longer repayment term won’t save on interest, but it will lower your monthly payments to make them manageable.

The bottom line

Using a business line of credit can support strong finances for your company, but it can also hurt them. Before withdrawing money, make a plan to manage the credit line and understand how the payments and fees will fit into your current budget.

Frequently asked questions

• Do business lines of credit require collateral?

  Secured business lines of credit require you to back the loan with business collateral, while unsecured lines of credit don’t. A lender may require you to sign a personal guarantee with either a secured or unsecured line of credit. This essentially guarantees the loan with personal assets.

• Is there a cost to using a line of credit?

  Yes, lines of credit have borrowing costs like any other business loan, including interest payments. Some lines of credit have a one-time origination fee when opening the credit line. Some also charge a draw fee each time you withdraw funds, usually a percentage of the loan amount.

• What is a disadvantage of using a line of credit?

  A business line of credit could cause financial strain if you draw more money than you need. Or you could get into a cycle of debt if you withdraw multiple times and have to manage more than one loan. As reusable credit, lines of credit are similar to business credit cards, except that they don’t have a grace period that lets you avoid interest if you pay off the balance in full.