What To Consider When Getting a Business Line of Credit
There are several ways businesses can utilize financing to fund growth projects, bridge economically slow periods, or maintain cash flow. One such way is a business line of credit, which provides access to funds typically in an amount less than a traditional loan but greater than the business’s working capital. Before opening a credit line, however, businesses should consider several factors to determine the best lender and financing options for their needs.
Qualifying for a Credit Line
Although some banks will require exceptionally good credit and excellent financial health in order to qualify for a credit line or business credit card, other non-traditional lenders will permit businesses to qualify for these credit products with less demanding criteria. Though the non-traditional lenders may hedge risk through higher interest rates or lower limits, shopping around for competitive offers will usually yield a credit product that will both permit a business to qualify for and permit the needs of the business to be met.
Interest rates for credit lines are typically variable, meaning the rates will rise and fall with the broader credit market over the course of the loan. When evaluating various lenders’ rates, businesses should be aware of how the lenders index their rates (e.g., the Wall Street Journal Prime Rate), and the criteria invoked by lenders to change the rate. Understanding the criteria behind the rate change can permit businesses to better time their credit line draws.
Credit Line Limits
Similar to more traditional financing, credit lines are also capped at a maximum amount based on what your business can qualify for. Just because your business qualifies for a higher credit line does not necessarily mean your business should draw on the credit line up to the maximum amount. Businesses should use a credit line as a tool of flexibility, drawing funds to cover minor or routine capital expenses, but not drawing so much that the business has difficulty paying down the credit line.
Paying down a credit line differs from repaying a more traditional loan. Instead of an equal number of principal and interest payments, credit lines have monthly minimums based on the balance or amount drawn. Those minimums are usually interest only. So just as the amount permitted to be drawn affords the business flexibility, so does the amount required to be paid each month. However, as the amount drawn rises, so does the amount required to be paid.
In addition to origination fees, lenders may also charge annual fees. Though not tied to the amount drawn on the credit line, these fees will add to the principal amount drawn and, therefore, impact the business’s minimum monthly payments. These fees can vary from lender-to-lender, and should be well understood before the business agrees to the lender’s terms for the line of credit.
A line of credit can provide businesses a very flexible funding tool. Credit lines may be obtained through a business banking relationship, or through less traditional, online lenders. Qualification criteria will vary, as will interest rates, fees, credit line limits, and repayment guidelines. Businesses considering a line of credit should evaluate all of these factors before deciding what best meets their needs, but the right credit line product could be just what a business needs to cover inventory costs, weather a slow economic period, or even facilitate expansion.