What is a business line of credit and how does it work?

A business line of credit provides small business owners access to short-term funding. This credit line can help cover business expenses like paying your employees or purchasing inventory.

Because a small business line of credit offers flexible financing for your business needs, many companies choose this financing option. Data from the Federal Reserve Banks’ 2023 Small Business Credit Survey revealed that lines of credit are currently the most popular financing option among American business owners, accounting for 43 percent of all applications.

Read on to learn more about business lines of credit and see if it’s the best business loan option for you.

What is a business line of credit?

A business line of credit is a flexible business loan that works similarly to a business credit card. Borrowers are approved up to a certain amount and can draw on their line of credit as needed, paying interest only on the amount actively borrowed. Funds are typically accessible through a business checking account or mobile app.

Unlike a traditional or term business loan, which disburses funds in a lump sum at one time and is repaid with interest, a business line of credit is renewable. As the borrower makes repayments, the amount of credit available is refreshed, similar to payments toward a credit card limit. Business lines of credit are typically approved for several months or up to several years, depending on the lender.

How do business lines of credit work?

Business lines of credit have loan amounts that are generally smaller than traditional business loans and are often funded more swiftly. Though traditional banks may take days or weeks to fund, many online lenders can provide access to funds as quickly as within a business day.

Repayment terms will also vary from lender to lender, from as short as several weeks to as long as several years. Interest rates tend to be higher than traditional business loans. Your rate will depend on several factors, including your credit history, time in business and annual revenue.

Common fees include an annual fee, an origination fee when you first apply, a maintenance or monthly fee on the account and draw fees each time you pull from the line of credit.

Secured vs. unsecured line of credit

A business line of credit is either secured or unsecured. A secured line of credit generally includes collateral, such as cash, investments or real estate. The benefit of providing collateral is generally more favorable loan terms and a lower interest rate.

To get an unsecured business line of credit, your business will need a solid financial profile (e.g., good credit score, at least two years in business, consistent or growing annual revenue). Because it raises risk for the lender, opting for unsecured business loans rather than secured generally may mean slightly higher interest rates.

You can also opt for an SBA business line of credit called SBA CAPLines. These lines of credit are available to businesses that can’t qualify for traditional lines of credit. Since these lines are backed with an SBA guarantee, lenders may be more likely to approve you since SBA lines of credit come with a reduced risk for the lender.

Can I get a business line of credit with bad credit?

It’s possible. Some lenders — especially online lenders — will work with business owners with a credit score as low as 500. But choosing bad credit financing means accepting certain drawbacks. Because you’re a risky proposition for the lender, they offer you less favorable terms like:

• Lower loan amounts. Lenders limit loan amounts for bad credit business loans to lessen the risk of lending to high-risk borrowers. Depending on factors like your business revenue and time in business, you may be limited to business loans for $100,000 or less.
• More frequent repayment. With bad credit, you may need to repay what you borrow more quickly, like on a weekly or biweekly basis.
• Short draw periods and repayment terms. To limit their risk, the lender may only offer you a short-term loan. That means they might only let you use the line of credit for a brief window. Additionally, they might require you to repay what you used within six to 18 months.
• Factor rates. Some lenders charge factor rates rather than interest rates to borrowers with bad credit. That can mean paying more in interest, ultimately making your line of credit more expensive.
• Fewer options. With bad credit, you’ll be presented with fewer choices. You likely won’t be able to get an unsecured business line of credit, for example.

Can I get a startup business line of credit?

Online lenders offer business lines of credit to startups. Some only require six months of time in business. Specifically, if you’re in your very early days, you can look into:

• Fundible
• Fundbox

If you’ve passed the one-year mark, you have more options, including:

• Backd
• OnDeck

The Wells Fargo Small Business Advantage® line of credit will help businesses newer than two years old, provided they have strong credit (a personal score of 680 or higher). Bank of America also has a cash-secured business line of credit that can help you build credit, which will help you qualify for more affordable financing down the road.

Requirements for a business line of credit

When you’re ready to get a small business line of credit, lenders will review your application to determine eligibility. Here’s a look at some of the important factors they will consider.

• Credit score. Lenders will consider your personal and business credit score. While it’s possible to get a line of credit with a low credit score, lenders typically prefer fair-to-excellent credit. The lower your credit score, the more you will pay in interest and fees, and the less likely you’ll have an unsecured business line of credit as an option.
• Annual revenue. Lenders will require that you have a minimum annual revenue. Some lenders are flexible and will consider businesses with an annual revenue of $50,000, but many prefer a revenue of at least $100,000 or higher.
• Time in business. This also varies by lender, but a minimum of six months to two years in business is standard.
• Collateral. If you can provide an asset to back your line of credit, you may qualify for a secured line of credit, which can come with lower interest rates.

Pros and cons of a business line of credit

Like just about anything else, getting a small business line of credit comes with some pros and cons. It’s important that you weigh them for your business before jumping in.

Pros

• Improved cash flow
• Accessibility
• Relationship-building with a lender

Cons

• Fees
• Higher rates
• Potential for short repayment terms

What to consider when getting a business line of credit

Getting a business line of credit works well when you have small to moderately-sized expenses. It also works well if you think you’ll use the line of credit again in the future. Most lines of credit are revolving, so the amount of money you can borrow replenishes as you repay previous draws.

Many business lines of credit have more lenient requirements to apply than a traditional business loan. You may still find options even with fair personal credit or low revenue.

But if you need a business loan for a specific, one-time purchase, getting a business term loan may make more sense. For example, getting an equipment loan would likely make more sense if you’re looking to purchase equipment for your business. You’ll get a lump sum upfront to purchase the equipment, and the equipment becomes collateral for the loan, potentially giving you a lower interest rate.

Bottom line

A small business line of credit can be an excellent and flexible solution for inconsistent cash flow in your small business. But like any form of financing, there are risks to consider. Comparing lenders to find a competitive rate and terms can save money over time.

While credit limits may be lower than what you could get with a small business loan, funds are often available more quickly, and borrowers can return to the well repeatedly without needing to reapply for funding.

Frequently asked questions

• What credit score do you need for a business line of credit?

  Lenders may look at both your personal and business credit scores. And while it’s possible to find a lender that offers a business line of credit to a business owner with bad credit, most lenders will require you to have at least fair credit.

• What is the difference between a business loan and a business line of credit?

  Business loans are disbursed in one lump sum and repaid by the borrower with interest over time. A business line of credit is approved up to a certain amount, and lenders can repeatedly borrow, using and repaying credit as needed. Business loans tend to have more favorable interest rates and longer repayment terms compared to a business line of credit.

• Where can I get a business line of credit?

  Banks, credit unions and alternative lenders may offer business lines of credit.

• Can I get a business line of credit with my EIN number?

  While some lenders may approve you using your Employer Identification Number (EIN) number alone, many will also require your social security number to determine creditworthiness. Many lenders will want a guarantee that you will be personally responsible for any debt you incur in the event your account goes into default.