What if you never had to worry again about a last-minute computer malfunction or a late payment from a customer again?
If you find yourself often facing cash flow problems or worrying about surprise costs that you won’t have the cash to cover right away, a business line of credit could be the way to go. By opening a business line of credit early on, you can make sure you’ll always have access to cash to tide you over.
But one of the problems with business lines of credit is that they often require collateral, meaning you’ll need to put some assets on the line to guarantee the funds you’re borrowing. Collateral makes the lender feel more secure in their decision to lend to you: if you can’t pay them back, they can just take whatever collateral you’ve posted and sell it off.
So what do you do if you’re desperate to have access to a line of credit but have no collateral?
There are a few options for you—but they’re just a little trickier to come by.
That’s where we come in. We’ve pulled together everything you need to know about unsecured business lines of credit.
The Basics of Unsecured Business Lines of Credit
We’re going to start at square one here. If you already know all about business financing, feel free to skip ahead.
Business Lines of Credit vs. Term Loans
With a typical term loan, you’ll receive the whole amount of the loan at one time. You then have a set period of time (the “term”) in which to pay it off, usually in predetermined increments. In addition to paying off the principal of the loan (that original amount you borrowed), you’ll also be responsible for paying interest.
If you don’t end up needing all of the money, you’re still responsible for paying it back, plus interest.
And if you borrowed money to make an investment that doesn’t end up panning out—the new equipment doesn’t speed up your productivity or increased staff doesn’t lead to more sales—you’ve still got to find a way to make your payments.
That’s one reason business owners sometimes don’t want to apply for term loans: they’re not very flexible.
Lines of credit, on the other hand, are much more flexible:
You can use them whenever you need and not use them when you don’t need them. They’re a useful, low-maintenance option to keep around.
(Of course, you do still have to pay interest on whatever credit you use.)
If one business owner had a term loan with a principal amount of $10,000 and a second business owner had a line of credit with a maximum of $10,000, both business owners would be able to use up to $10,000 of financing. But let’s say that they each only ended up needing $5,000. The owner with the term loan would need to pay back the entire $10,000 plus interest anyway, while the one with the line of credit would only need to borrow and pay $5,000 plus interest.
That’s a whole lot of savings.
Interest rates on lines of credit also tend to be lower than those for term loans—unless you’re late in making your payments, in which case those rates can skyrocket. For a term loan, on the other hand, they’ll stay the same no matter what.
The other thing about lines of credit is that they don’t have a term at all.
They’re what we call revolving credit, which is exactly what it sounds like:
Like a revolving door rotates around and around (but only when someone pushes it), lines of credit can be used again and again… As long as they’re paid off. You’ll be authorized to borrow up to a specific amount, and once you pay off whatever you’ve borrowed, you’re free to continue borrowing again up until that limit.
So in the case of the business owner with the $10,000 maximum, after he has spent that $5,000, he’ll be able to spend $5,000 more. If he doesn’t—and he pays the original $5,000 back right away—he’ll be back to getting to spend $10,000, without having to reapply for another line of credit.
What’s the difference between a business line of credit and a business credit card?
Actually, not that much. The word “card” pretty much sums up the difference: with a business credit card, you’ve got a piece of plastic to use instead of a cash advance.
So if you tap into your business line of credit, you’ll get a deposit into your bank account. With a business credit card, you’ll swipe the card.
The Small Business Administration describes business lines of credits as “traditional” lines of credit and business credit cards as “non-traditional” lines of credit.
Traditional lines of credit offered by banks often require you to gather extensive paperwork during the application process, like personal and business tax returns and bank statements. They’re also monitored every year by a process called the annual financial review to make sure that the business owner can maintain that line of credit. (Alternative lenders tend to be a little less stringent here.)
On the other hand, applying for a business credit card depends on your credit score instead of all of this documentation—so it might be a little less of a hassle.
But that doesn’t necessarily mean a business credit card is a better option for you. Credit cards generally need to be paid off monthly, even if only with a minimum payment, while line of credit repayment is more flexible.
And if you need cash to make your purchases, a line of credit is a better bet: cash advances from credit cards can be pretty expensive.
What types of purchases are a line of credit best for?
Lines of credit are best used for short-term, smaller, or more frequent purchases, like inventory or for managing cash flow. (For example, if your employees are paid in the middle of the month but your invoices often aren’t fulfilled until the end of the month, you can use a line of credit to cover the gap so that your employees are paid on time.)
For bigger one-time purchases, like equipment, it’s better to use term loans. You don’t want to tie up your line of credit for these purchases, because then it won’t be there for when you have smaller or unexpected costs.
What do “secured business lines of credit” or “unsecured business lines of credit” mean?
A secured line of credit, like a secured loan, is more “secure” for the lender because it requires you to post some sort of deposit or collateral.
This could be real estate or some other personal asset that the lender could sell off if you default on the loan, or it could be a cash deposit, like with a secured credit card.
Unsecured lines of credit, you might have guessed, are… Not secured. No collateral involved, just like unsecured loans.
As a business owner, of course, you’d much rather open an unsecured line of credit so that you’re not risking any of your personal assets.
But of course, there’s a catch: you often need to have high annual revenue and a high personal credit score in order to secure one of these unsecured loans (or an unsecured business credit card).
Unsecured Business Lines of Credit
If you have lower revenue and personal credit, you can look into OnDeck and Kabbage, which are easy to apply for and will deposit money into your account within just a few days.
On the other hand, these lines of credit have high APRs, making them expensive options for you. You also might not be able to get a very high credit limit—so you have fewer options for using the money.
If you have a slightly higher credit score and annual revenue, you can qualify for lines of credit with higher credit limits and lower APR, letting you make more purchases and ultimately pay less money. These lenders, like Lending Club, might be a little slower in evaluating your application and providing you with funding, and the more complex application will take more time for you to fill out.
If you’ve got a fantastically successful business that’s been up and running for years, a stellar personal credit score, and the patience to gather together lots of paperwork, you can apply for a bank line of credit.
But beware: 4 out of 5 small business owners who apply for a bank line of credit are denied, and even the ones who get approved face infamously long wait times.
What about unsecured credit cards?
If you’ve got a desirable credit score, business credit cards are another unsecured option for you. They’re faster and easier to apply for, and many of them offer 0% introductory APR rates for the first year.
Secured Business Lines of Credit
Putting up collateral on a line of credit lets small business owners with lower revenues and credit scores get higher credit limits with lower interest rates. A secured line of credit might be backed by invoices or equipment, or it could be a secured credit card, which requires a deposit.
1. Invoice-backed Line of Credit
Invoice financing is an excellent choice for businesses that rely on invoicing customers… And have to wait for those invoices to be paid.
If you repeatedly find yourself confronting cash flow problems, you can use invoice financing to cover the gap between the time you issue the invoice and the time you’re paid for it. The lender is helping you to be paid for your invoices right away, in other words, and then when you do receive the money from your customers, you can pay the customer back.
Invoice financing can also provide you with a term loan instead of a line of credit, but the advantage of an invoiced-backed line of credit is that it’s more flexible, so you can borrow more money if you have more invoices due—and vice versa.
2. Equipment-backed Line of Credit
An equipment-backed line of credit is just like an equipment-backed loan. If you need financing to buy a piece of equipment, that equipment can serve as your collateral.
(Until you pay the lender back, they have the right to seize that piece of equipment in case of default.)
3. Inventory-backed Line of Credit
Inventory-backed lines of credit are exactly the same idea as equipment-backed ones, except they use your inventory as collateral instead of your equipment.
If you need financing to fund inventory purchases, inventory-backed lines of credit will let you get lines of credit with low interest rates.
You’ll only be able to use the credit for inventory purchases.
4. Secured Credit Cards
Secured credit cards aren’t really useful if you need financing, because they require you to put down a deposit that’s usually equal to the limit on the card. If you needed $5,000 to cover your payroll expenses until your customers pay off their bills, forking over $5,000 to get a credit card with a $5,000 limit isn’t going to help you.
What they are good for is building your business credit, which can help you qualify for better lines of credit in the future.
If you have low or no business credit, you can still apply for and receive a secured credit card. After you’ve consistently made payments on time for several months, your credit score might be high enough to move on to a better option.
Applying for an Unsecured Business Line of Credit
Whether you’re applying for an unsecured line of credit from a bank or from an alternative lender, apply for a line of credit before you need it!
There’s no downside to taking out a line of credit loan before you need it—and then when you do need it, it’s there immediately. You won’t need to scramble to get your application together or wait for the lender to evaluate and approve your application.
The application process will change from lender to lender. Here are a few things you might be asked for:
- Bank statements (from at least the past 3 months, but often more) to show off your positive cash flow.
- Profit and loss statements to show the lender your revenue and your expenses.
- Essential business identifying information, like how long you’ve been in business, what industry you’re in, and how many owners there are. Banks will want you to have been in business for at least 2 years, but alternative lenders are willing to work with newer businesses.
- Your personal credit score.
- Personal and business tax returns to verify your revenue.
- A balance sheet showing your assets and liabilities.
- A personal guarantee. Be careful here! Unlimited personal guarantees allow the lender to go after your personal assets if your business can’t pay off its debts.
Who usually takes out a business line of credit?
Curious about the small business owners who use lines of credit?
75% of Fundera customers who have been approved for a business line of credit have been in business for over a year, have an annual revenue of at least $180,000, and have a credit score of at least 630.
If you’re at or over those benchmarks, you’re probably in pretty good shape to get a line of credit.
Of course, interest rates and maximum amounts of credit will vary depending on your time in business, credit score, and annual revenue.
Lines of credit are a versatile, easy financing solution that work well for a wide range of businesses and needs. And if you don’t want to sign away your personal assets, no problem: there’s a lot of options out there for unsecured business lines of credit.
Think of a business line of credit like an insurance policy—cash that’s there for you if and only if you need it.
from Fundera Ledger https://www.fundera.com/blog/2016/07/26/unsecured-business-lines-of-credit/