As a fledgling entrepreneur, you are probably not alone in wondering: What is a business line of credit? Naturally, you have heard of this as one of your options when you decide to start your own small business. It’s important to learn more about it and know the pros and cons so you can decide whether it’s the right type of funding for you.
Business Line of Credit Explained
A business line of credit is a type of funding extended to business owners that is similar to a business credit card. With the line of credit, you have a specific maximum balance and use the money from it when you need it. Similar to a credit card, you then make monthly payments toward the amount of money you have used. You are required to pay the minimum amount based on the current balance.
What are the Pros of a Business Line of Credit?
A business line of credit is an attractive option for small business owners to fund their company in a number of ways. They offer numerous benefits, including the following:
- Evens out cash flow: At some point, every business has issues with earnings being less than expenses. A business line of credit can even out your cash flow, allowing you to pay your employees and vendors on time. According to Lantern Credit, “A business line of credit can be a great option to maintain cash flow and take care of short-term business expenses”
- Lets you pay for necessities: Business lines of credit are good for paying for your necessities. As a result, you get just the right amount of money toward the loan and only pay the interest on the amount used.
- Lets you take advantage of opportunities: A business line of credit enables you to take advantage of great opportunities for your business that you might otherwise not have if your finances aren’t up to par.
- Builds a relationship with the lender: Although business lines of credit function similarly to credit cards, they differ in that you are able to establish a relationship with the lender. As a result, you can secure other types of loans with the same financial institution based on your relationship with that lender, get more funding and secure even better terms.
- Helps you build credit: Using a business line of credit can help your small business to establish and build credit as well.
What are the Cons of a Business Line of Credit?
Like anything else in business or life, in general, a business line of credit isn’t perfect. As a result, it’s only natural that there are certain disadvantages to them. As a result, it’s wise to get all the facts and make the best decision based on that knowledge. The following include cons of business lines of credit:
- They can be expensive: While they aren’t as expensive as business credit cards, business lines of credit typically carry high interest rates with APRs that can be higher than 20 percent. They may also carry additional fees that can be costly.
- Difficult to qualify for: It’s difficult to qualify for a business line of credit. When you apply, you must present financial and personal tax returns, bank account information, financial statements and business documentation. Two years of operation is also required for small businesses to qualify, which can be problematic.
- Temptation for misuse: Sometimes, it can be tempting to use funds from a business line of credit for the wrong things. If you accidentally borrow against it, it can work against you. You must be extremely disciplined to have a business line of credit.
- Low borrowing limits: Due to the low borrowing limits set forth by business lines of credit, it’s easy to amass too much debt.
With all of these details in mind, you are better-equipped to decide whether a business line of credit is right for you.