What Is A Line Of Credit?
A business line of credit, often referred to as an LOC, is a form of business finance that allows you to borrow from an agreed upon amount of money as and when you need it. A line of credit is an effective tool for businesses that want to improve cash flow, but there are some downsides, so it is important that you understand the pros and cons before using a line of credit.
How does a line of credit work?
A line of credit works in a similar way to a personal credit card. You will apply for a set amount and agree upon it with a lender. Once approved, you are free to borrow as little or as much of that amount as you like, as and when you need it. You will be charged interest on anything that you borrow.
The different options available
There are two main types of line of credit available; unsecured and secured. An unsecured line of credit does not require you to put up any assets or collateral against the money that you borrow. A secured loan, however, will need to be backed by some material asset and the lender will take ownership of those assets in the event that you are unable to pay the money back. A line of credit differs from a standard business loan because you only pay interest on the money that you draw down, rather than the entire sum.
How much can you borrow?
The amount that you can borrow on a line of credit depends on your specific business circumstances. Different lenders have their own way of determining what your credit limit should be. For example, one lender may cap it at a percentage of your gross revenue, while another may base the figure on your available cash flow.
Lenders also vary a lot where repayment terms are concerned. The majority of lenders will choose a loan repayment term of somewhere between 3 and 30 months, but there are also options for a revolving line of credit. If you take out a revolving line of credit, there is no repayment term. You simply pay back the money that you have drawn down and then you are free to use it again when you need it.
Interest and fees
When you apply for a line of credit, you will usually be charged a one-off application fee. This will be somewhere between 0.5% and 3% of your approved credit limit. Interest rates vary between lenders and will be determined based on your financial situation.
A business line of credit is an effective funding tool for businesses, but it is important that you are able to manage the balance well so you can avoid large interest payments.