For many small business owners, business is tighter than usual right now. The coronavirus has left many businesses without their normal influx of customers, which threatens cash flow.
At times like these, wouldn’t it be nice if you had a stash of cash to fall back on? Some lucky business owners do—those who have a business line of credit. But too many small business owners are so determined to avoid debt, they don’t even consider applying for a line of credit.
That kind of thinking can actually hurt your business, because when you need some extra money, it’s not there, or it will take too much time to get funds.
So, what exactly is a line of credit? It’s a revolving line of credit, much like a credit card. You can borrow (draw) money up to your limit. When you repay the funds, you replenish the line, making it available for you to draw upon again.
Let’s say you have a business credit line of $25,000 and draw $25,000. You can’t borrow any more money, until you pay some back. If you repay $5,000, you can borrow that amount again. And you don’t have to reapply to credit.
If you repay the whole amount, you can draw upon that. And if you don’t have an immediate need, most lines of credit can just sit there, waiting to be tapped. If you don’t borrow from it, there are no charges or fees.
I’m not telling you to go borrow money you don’t need. But given that we don’t know how long the economy is going to be impacted by COVID-19, now may be the perfect time to get a line of credit.
Before you apply for a business line of credit, here are some things you should know.
What are the terms?
Make sure you fully understand the terms of the line of credit. How often will you need to make payments? How long is the term of the line? Are there prepayment penalties? Unlike business loans, which usually require monthly payments, some business lines of credit offer the flexibility to choose monthly or weekly payments.
What is the total cost?
Make sure you add up the fees and any other costs associated with getting a line of credit. Find out if there are any potential penalties. Ask:
- Is the interest rate fixed or variable? If the latter, can you handle it if interest rates go up?
- What happens if your payment is late? Does that increase your interest rate? Will you get charged a penalty?
- Does the lender charge a fee for drawing down money or just having the line of credit even if you don’t actually use it?
How quickly can you access funds?
If you anticipate needing money in a hurry, to meet payroll or pay for an expedited shipment of merchandise, you’ll want a business line of credit that allows you to get immediate access to your money. Some lines make you wait longer.
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What’s the difference between a secured and unsecured business line of credit?
Secured lines of credit are typically offered by banks and require you to put up some type of collateral, such as business equipment, machinery, or inventory. (This is similar to a home equity line of credit, in which your house serves as collateral.)
Unsecured lines of credit don’t require collateral, making them easier to get. Be careful, though, these often charge higher interest rates.
Are there stringent requirements to get a line of credit?
Typically, banks have more stringent requirements for approving a business line of credit than alternative lenders. Banks may not approve startups or relatively young businesses for a line of credit. Or they may want these types of businesses to get a secured line, requiring collateral.
Today, there are numerous fintech companies (alternative lenders) offering business lines of credit with fewer requirements. Other conditions may hinge upon being in business for a certain number of years or earning a minimum amount in annual revenues.
These are important considerations, so check the lender’s requirements before you apply.
Does having a business line of credit hurt or help my credit rating?
In this regard, having a line of credit is similar to using a credit card. Borrowing small amounts of money on your line of credit and making timely payments will (gradually) boost your business’s credit score since it shows you can responsibly manage credit. Over time, this will make it easier to qualify for other types of financing or a larger business line of credit in the future.
Are there certain businesses that should always have a line of credit available?
- Seasonal businesses often encounter cash flow problems during the slow season. Having a line to tap to pay bills or order merchandise can make the difference between survival and having to close up shop.
- Do you have a lot of slow-paying clients? Tapping a line of credit while you wait for the money to show up can be a business saver.
- If you’re choosing between getting a line of credit or applying for a business loan, lines of credit are easier to get approved for. And if you don’t want to put up any collateral, getting an unsecured line of credit could be the perfect solution.
If you’re still uncomfortable with the idea of borrowing money, think of a business line of credit as an emergency fund that you tap only when you need it. If you never use your line of credit, it costs you nothing. If you need it, it’s there. There’s really nothing to lose.
It’s smart to apply for a business line of credit when you aren’t in desperate need of the money. So even if you don’t need one right now, consider applying. It’s always easier to get approved when you’re in a strong financial position, than when you’re in a cash crunch.
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