How to manage a business line of credit

A business line of credit (LOC) can be a helpful alternative to a business term loan because you can access the line of credit whenever you need it. 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 2024 Small Business Credit Survey by the Federal Reserve Banks, 40 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.

Learn how to use your business line of credit effectively so that you can make essential business purchases and use the credit line again in the future.

Why managing your business line of credit is important

A business line of credit can be a great tool for businesses if you use the line of credit properly and repay the debt in full. It could boost your credit score as the lender reports your timely payments to the business credit bureaus.

However, if you mismanage the line of credit and take on more debt than your business can handle, you could end up damaging your credit. You might even get into a cycle of debt that’s difficult to get out of. If you fail to make repayments, you could even end up in default or business bankruptcy. To avoid these scenarios, you want to understand the full cost of the loan before you make a withdrawal to ensure that you can repay it.

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 business 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 if you can make small purchases in cash or you can find more capital by rearranging your budget. 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 the cost of the loan before you withdraw funds

Typically, you start accruing interest on a LOC when you draw funds. To help you manage payments, know your interest rate and how much the total repayments are 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 = $10,549.91
• $10,549.92 (total loan cost) – $10,000 (original loan amount) = $549.91

4. Make on-time payments

To avoid late payment fees, making your payments on time is vital to any business loan. You can set up automatic withdrawals from your business checking account to make sure that you make all payments on time, without having to remember the due date.

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.

Alternatively, you may decide to swallow the extra interest payments to keep more cash flow in your business. If you have an unusually successful month, you could decide to save money in your business emergency fund that you can use to make loan payments in the future. 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)

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. If you use your business line of credit in this case, you may get into a cycle of debt that you won’t ultimately be able to repay.

To help your business cash flow, you can start by taking a hard look at your business budget and seeing where you can adjust expenses. You may also want to think about refinancing existing debt into a loan with a longer repayment term or lower interest rate. If you have multiple loans, consider consolidating your loan into one loan, preferably with a lower interest rate. These strategies should provide you with some debt relief.

Consider talking with your current lender about these options or comparing other small business lenders to find the best loan.

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. Then, make on-time payments to build a positive payment history that will help you qualify for better terms and interest rates in the future.

Frequently asked questions

• Do business lines of credit require collateral?

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

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