What Is a Line of Credit and How Does It Work?
Funding growth opportunities while keeping up with the day-to-day costs of running a business can be downright overwhelming. Although you may be tempted to open another business credit card or take out a loan, there are situations where these solutions may not be the best fit. For example, loans often have restricted financing capabilities, while business credit cards may not offer a high enough credit limit to fund what you need.
If you find yourself in this situation, it may be time to pursue a line of credit. But what exactly does this mean? A line of credit is a financing option where a lender provides a select credit limit for you to draw funds. Lines of credit are fairly flexible, allowing you to use all or part of the allotted credit wherever and whenever you need it, so long as you stay within the draw period.
In addition to flexibility, the line of credit process is reasonably straightforward. After your application has been accepted, your lender will determine your limit, decide your interest rate, and set your repayment schedule. However, it’s important to keep in mind that the terms of your repayment plan are not set in stone and can be adjusted.
Of course, these are just the basics. To give you a more comprehensive look at how opening a line of credit works, the Backd team came together to answer some frequently asked questions.
Line of Credit FAQs
Understanding how a line of credit works can be challenging, but we’re here to arm you with all of the information you need to make the right decision for your business.
What’s the Difference Between a Line of Credit vs a Credit Card?
All credit cards are technically a line of credit, but not all lines of credit come through a credit card company. Additionally, business credit cards often have lower credit limits when compared to a line of credit. According to Experian, the average business credit card limit sits at $56,100, which may not go far in some cases.
Does a Line of Credit Need to be Paid Back?
In this case, a line of credit is not so different from a traditional loan. Every line of credit requires you to pay interest and repay the borrowed funds. Like loans, using and repaying a line of credit improves your overall credit score. However, if you fail to make payments on time.
Can You Get Denied a Line of Credit?
Yes, it is possible to be denied a line of credit. Although the reasons vary depending on the situation, here are some of the most common issues that can cause your application to be denied:
A Low Credit Score: If your personal credit score is low, or if you have no established business credit, this tells the lender you may not be able to repay them if they offer you a line of credit. For example, at Backd, we require a personal credit score of 600 or higher.
Low Sales Figures: If your business has seen a recent or frequent downturn in sales, a lender may be less confident in your ability to pay your debts. This could affect your qualification for a line of credit.
Too Many Open Credit Lines: Having multiple forms of credit open and a large number of outstanding debts may give lenders pause as they review your line of credit application.
Do You Need Collateral for a Line of Credit?
Although secured lines of credit do require collateral, unsecured options do not. Most line of credit options is classified as unsecured. However, secured options tend to have lower interest rates because collateral is involved.
Why Use a Line of Credit Instead of Cash?
Often businesses, especially small businesses, do not have enough cash to fund growth-minded ventures or other expenses. Taking advantage of a business line of credit allows you to fund whatever you need when you don’t have the means to cover all costs upfront.
How Does Line of Credit Interest Work?
When using a line of credit, you are only required to pay interest on the funds you spend from your credit line. Once you borrow money from your line of credit, interest starts to accrue. So long as you meet your minimum payments, the amount of debt you pay off will be added back to your available line of credit. After the end of your draw period, the repayment period begins. This means you have a set time to settle your remaining balance. Lastly, you are encouraged to make more than your minimum payments to prevent increased interest rates in the long run.
What Is the Main Advantage of a Line of Credit?
Flexibility is the most significant advantage of pursuing a line of credit. A line of credit lets you withdraw funds as much as you like, so you can keep up as the financial needs of your Business ebbs and flow. If you are interested in pursuing straightforward and flexible funding solutions to grow your business, then you need a partner to support you throughout the whole process. At Backd, we connect you to fast, easy, and affordable solutions to fund your business.
Our line of credit program offers instant access to revolving credit with unlimited terms and affordable interest rates. With Backd you can draw from your line of credit anytime and use the funds for anything you need.