What is a business line of credit, and what can it do for your business?

What is a business line of credit?

A business line of credit is a flexible loan for businesses. It works in a similar way to a credit card in that you can borrow funds as and when you need to up to a set limit. You can borrow a lump sum or draw smaller amounts as required, and the lender will only charge interest on what you have withdrawn.

Lines of credit can be secured or unsecured. As with secured business loans, a secured business line of credit requires you to use an asset (such as property) as security against the borrowed amount. Should you fail to repay the borrowed sum, the lender has the right to take possession of the asset to reclaim its money.

If your line of credit is unsecured, you won’t need to offer an asset as collateral. However, this usually means you can’t borrow as much as with a secured business line of credit, and interest rates can be higher, too. 

How does a business line of credit work?

When you apply for a business line of credit, your lender will tell you the maximum amount you can borrow. This amount is called your credit limit. You can borrow any sum up to this limit whenever you need to, and you’ll only pay interest on the amount you’ve used. 

Unlike a business loan, you won’t have to make fixed monthly repayments to repay it. Instead, you can usually choose how much you want to pay and when, as long as you repay the full amount by the date you agreed with your lender. You can even repay the loan early without incurring an early repayment charge.

Depending on the agreement, your business line of credit might expire after a set time, or it could revolve. If it revolves, you can reuse the funds once you’ve repaid them without reapplying.

For example, let’s say you receive a business line of credit of £40,000. You withdraw £10,000 to pay for inventory. The lender will only charge interest on the £10,000, and you still have £30,000 left to draw down if needed. You then borrow another £5,000 to cover an unexpected bill. You can use these funds before you’ve repaid the first £10,000, as long as you don’t exceed your credit limit.

How does a business line of credit compare to a business loan?

The main difference between a business line of credit and a business loan is that you can borrow and repay funds more flexibly with a line of credit. 

A business loan lets you borrow a lump sum of cash that you then repay in fixed monthly repayments over a set term. You can usually borrow a larger amount than with a line of credit, making a business loan more suitable for high-value purchases. 

A business line of credit, on the other hand, lets you borrow up to your credit limit when you need it. You might not use the full credit limit and you only pay interest on the amount you borrow. Repayments are also more flexible, and you can repay your loan early without penalty. A business line of credit can be useful for paying for repairs to equipment or covering day-to-day expenses when cash flow is tight.

How does a business line of credit compare to a business credit card? 

A business line of credit and a business credit card work in similar ways, but business credit cards are almost always unsecured, meaning you don’t need to offer any collateral to secure your borrowing.

By contrast, you can offer to secure a business line of credit with an asset, which usually results in a lower interest rate. 

Advantages and disadvantages of a business line of credit

Pros

• Flexibility: You can borrow funds up to your credit limit as and when you need to and make flexible repayments

• No early-repayment penalties: You can repay the borrowed sum as soon as you like without incurring a fee

• Quick application: Business lines of credit are generally available quickly via an online application process

• Can boost your cash flow: A business line of credit can enable you to cover business expenses when cash flow is tight

Cons

• Secured lines carry a risk: You need to use an asset as collateral if you want a secured business line of credit. This asset could be at risk if you fail to repay your borrowing in time

• You may need to reapply: Your business line of credit might only last for a fixed length of time, in which case you’ll need to apply for a new line of credit periodically

• Not suitable for long-term borrowing: A business line of credit is best suited to short-term borrowing rather than long-term funding 

• Interest rates can be high: You might pay a higher interest rate with a business line of credit compared to a business loan because of its flexibility 

How to get a business line of credit 

If you want to apply for a business line of credit, follow the steps below:

1. Check your credit rating

It’s sensible to check your business credit report before you apply for any type of credit. If you have a good business credit score, you’re more likely to be accepted and secure a competitive interest rate. 

2. Gather together the required documents

Before considering an application for a business line of credit, lenders typically ask for proof of your business finances, including balance sheets, income statements and bank statements. Make sure you have these to hand before applying. Some lenders will only offer you a line of credit if you’ve been trading for a number of years and meet a minimum turnover level.  

3. Look for a lender and apply

Business lines of credit are available from banks, credit unions and independent online lenders. Shop around to compare what’s on offer and check eligibility criteria before deciding. You can usually apply for a business line of credit online.