Business Lines of Credit Explained
How revolving credit works — limits, rates, fees, and smart usage for small businesses
- Revolving access to a pre-approved limit; pay interest only on what you draw.
- Two main types: secured (lower rates, collateral) and unsecured (faster, higher rates).
- Costs include APR/interest, draw fees, maintenance fees, and sometimes inactivity fees.
- Best for short-term needs: working capital, inventory gaps, marketing pushes, emergencies.
What is a Business Line of Credit?
A business line of credit (LOC) is a revolving funding account with a maximum limit. You can draw funds when needed, repay, and draw again—much like a credit card, but typically with lower rates and flexible repayment schedules. You pay interest only on the drawn balance, not on the entire limit.
Secured vs. Unsecured
- Secured LOC: Backed by collateral (cash, AR, inventory, equipment). Pros: higher limits, lower APR. Cons: more underwriting, liens/filings.
- Unsecured LOC: Based on credit profile and cash flow. Pros: fast, fewer docs. Cons: smaller limits, higher rates, personal guaranty likely.
Typical Costs & Fees
- APR / interest: Fixed or variable. Interest accrues only on what you draw.
- Draw fees: A small percent per draw (common with fintech LOCs).
- Maintenance or facility fees: Sometimes charged monthly/annually for access.
- Inactivity fees: Rare but possible if you don’t use the line.
How Limits Are Set
Lenders look at time in business, monthly revenue and volatility, margins, existing debt, business and personal credit, and collateral quality. Many lenders also evaluate your bank statements for average balance and number of negative days.
When a LOC Makes Sense
- Covering payroll or vendor timing gaps.
- Buying inventory you’ll turn over quickly.
- Launching short marketing campaigns.
- Cushion for unexpected repairs or seasonality dips.
When Not to Use a LOC
Long-term assets (e.g., equipment, buildouts) generally fit better with term loans—so the payback window matches the asset’s useful life.
Documentation Checklist
- Driver’s license, EIN, entity docs.
- Last 3–6 months business bank statements.
- YTD P&L and prior-year tax return (limits vary by lender).
- AR aging / inventory list (for secured LOCs).
Smart Usage Tips
- Draw for short needs, pay back quickly. Keep utilization low; it may help pricing and future increases.
- Monitor fees. If you draw rarely but pay maintenance fees, compare alternatives.
- Separate working capital vs. projects. Use term loans for big one-time investments.
- Keep clean cash-flow hygiene. Avoid frequent NSFs; lenders watch this.
LOC vs. Credit Card vs. Term Loan
| Feature | Line of Credit | Credit Card | Term Loan |
|---|---|---|---|
| Purpose | Short-term needs | Small purchases; rewards | Projects & assets |
| Cost | Interest+fees on draws | APR; convenience | Fixed/variable amortized |
| Repayment | Flexible, interest-only possible | Monthly; revolving | Fixed schedule |
| Limit | Moderate–High | Low–Moderate | Based on project size |
Frequently Asked Questions
How is interest calculated on a LOC?
Interest accrues only on your outstanding balance (not on the full limit). If your balance is zero, interest is typically zero—though some lenders charge small maintenance fees.
Will a LOC affect my credit?
Most business LOCs require a personal guaranty and may report to business and/or consumer bureaus. Low utilization and on-time payments can help your profile; frequent NSFs or late payments can hurt it.
What limit can I qualify for?
Limits are tied to your revenue consistency, margins, banking health, credit strength, and collateral (for secured LOCs). Many lenders set limits between 1–2× average monthly revenue as a rough starting point.
Is a LOC better than a term loan?
It depends on use. For short-term, repeat needs, a LOC provides flexibility. For one-time, long-term investments, a term loan usually fits better.