There are many lending options available to entrepreneurs, but how do you know which one is right for you and your business? Even if you’re confident in the loan type you want, it’s worthwhile to spend a little extra time understanding the fine print before signing a contract.
Because there are many lenders and plenty of short- and long-term financing solutions, it’s easy to be overwhelmed with options—several of which might sound the same, but they’re certainly different!
How can you spot the difference? We’ll tell you that and more about true lines of credit.
What Is a Line of Credit?
A line of credit’s key feature is that you have a maximum lending amount, established by the bank or lender offering the line of credit. You can take draws up to that maximum amount on a rolling basis. Depending on the lending agreement, you may have to pay interest on any account balance they maintain after a payment cycle.
Line of Credit: The Key Differences
The flexibility and function of a line of credit unfortunately make it easy for customers to confuse a true line of credit with other, longer-term financing solutions.
Some products have subtle differences that could result in additional restrictions, altered payment terms, or other constraints that might be different than the customer’s original expectations.
Other products may offer some benefits of a line of credit, but not the full package. Check for these attributes when evaluating your ongoing small business financing solution:
- Front-loading fees, making early repayment savings little to nonexistent. Some lenders set up a structure in which the largest amount of fees are due during the first 2 months of your loan. This can make the amount you potentially save through early repayment much less than if the fees were split out evenly throughout the lifespan of the loan.
- A fixed amount of fees from the onset of the “loan,” removing benefits or savings potential from early repayment. Not all lenders base their loan repayment structure on principal- and interest-based amortization schedules, as true lines of credit do. Some are set up in a manner that locks in fixed fees based upon the size of the loan once you sign the contract.
- A lien put on any business that has taken out a loan with them. Liens allow lenders to collect and sell a business’ assets in order to collect on past due debt obligations. It’s important to understand how liens work before taking out a loan with lenders that place one on your business.
Our table below describes some of the major differences between a true line of credit for business and other hybrid solutions. These could be a merchant cash advance, purchase of receivables agreement, and invoice factoring, sometimes confused with a line of credit.
|Detail||True Lines of Credit||Other Loans|
Monthly or weekly
Regular (daily or weekly)
|Based on a comprehensive business evaluation (may require a personal guaranty)
|Potentially easier to obtain due to less thorough checks
|Potential fees + complicated contracts that either front-load interest or require fixed payments
|Interest rate established based on complete evaluation of business credit and history
|Factor rates instead of interest rates (The total cost of a loan when factor rates are being used is calculated by multiplying the rate by the total advance your business is receiving)
What are Some Other Potential Differences to Watch Out For?
- Additional underwriting every time you decide to take a draw from your line. True lines of credit allow a business to draw up to their available credit limit, at any time, as long as they are in good standing.
- Point additions or origination fees from brokers that can yield higher interest rates than advertised. Some lenders hire brokers who receive commission from the addition of interest points to your loan.
- Restrictions on your ability to transfer credit card processors.
- Requirements for your customers to directly pay your lender in some cases.
When you need business funding, it’s important to read through all the fine print and make sure the solution you choose isn’t just best for you right now, but best for long-term financial sustainability.
The post What Makes a True Line of Credit Unique? Here’s What You Should Know appeared first on Fundera Ledger.
from Fundera Ledger https://www.fundera.com/blog/2016/10/21/true-line-of-credit