Business Lines of Credit: What Are They, How They Work, and Best Options [2024 Guide]

What Is a Business Line of Credit?

A business line of credit is a small business funding tool that provides a revolving pool of credit that can be accessed on an ongoing basis, as opposed to a single lump sum via a traditional bank loan.

Revolving credit is exactly what it sounds like: once approved, you get access to a revolving balance of credit which you can use for a variety of purposes.

Lines of credit are designed for the business owner who wants flexibility with the way term of repayment. 

There are multiple financial products that fall under the LOC umbrella, along with a variety of uses.

So, in this guide, we’ll cover how a business line of credit works as well as:

• Types of business lines of credit
• Pros and cons
• What you can use a business line of credit for
• Business line of credit rates
• And 5 things to know when applying

Apply for a Business Line of Credit with Excel Capital

At Excel Capital, we know that access to funding can make-or-break a business.

We’ve helped thousands of business owners obtain the capital they need to stay afloat, invest in the future, and move their business forward.

Apply for a business line of credit with Excel Capital today:

Get the capital your business needs– fast. Apply for a business line of credit with Excel Capital: Apply Now

2 Types of Business Lines of Credit

For starters, there are two main types of commercial credit lines offered:

Each type of line of credit has its own unique benefits. Which of the 2 you choose will depend on your business needs:

1. Unsecured: An unsecured business line of credit doesn’t require collateral, however, the line of credit is typically smaller along with a higher interest rate when compared to a secured line of credit.

2. Secured: A secured business line of credit interest rates are cheaper, making it the more attractive option for business owners. However, because they’re riskier for lenders, they need to be backed by some sort of asset usually commercial real estate or other assets.

That collateral can be capital such as property, however, it typically comes in the form of inventory, accounts receivable, or something else. If you’re unable to pay back the loan, your lender may seize that collateral to pay the balance.

Figuring out which of the above types of business credit lines are best for you and your business is an important part of the process of applying for a line of credit for your small business.

Before applying, consider various factors such as the state of your business cash flow including your average ledger balance in your bank account, your revenue and your accounts receivable and the forecast for the coming year to decide which would better fit your unique situation.

With that said, let’s talk about how lines of credit actually work and why they’re useful.

How an Unsecured Business Line of Credit Works

How a line of credit works is quite different than your average loan. A commecial line of credit uses what is called “revolving credit”.

Revolving credit is exactly what it sounds like: once approved, you get access to a revolving balance of credit which you can use for a variety of purposes.

As you pay off the balance, that credit once again becomes available and the process can be repeated over again for the length of the credit line.

For that reason, lines of credit work much more similarly to credit cards than traditional loans, which offer a lump sum once and then you’re done.

However, they’re different from business credit cards in many ways as well.

With credit cards, you get a preset spending limit.

However, while similar, with a line of credit for small business it’s not so much a preset spending limit as it is a max approval amount.

This gives you the flexibility to draw down as the need arises until you’ve maxed out the line of credit. Typically, with either 6 or 12-month repayment windows.

Once requested, the funds are then either wired or ACH’d directly into your business checking account.

This is different than a credit card since you have to swipe the card with a vendor who accepts credit cards if you want to use the funds. In addition, if you need cash you have to pay hefty fees.

Once maxed out, you can continue repaying and reusing the funds within your line of credit provided you make payments on time and never exceed your credit limit.

Many business owners confuse Business Lines of credit with unsecured loans or merchant advances but they are very different.

With business LOC, you only pay for what you use and keep the unused funds on reserve for emergency business needs with no cost of funds.

As long as the line of credit is open you do not need to go through any more underwriting or submit any more paperwork

This way you have the comfort of knowing you have access to capital with the click of a button without any paperwork or waiting.

Complete our online application and see how much you can be approved for: Apply Now

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Business lines of credit vs. business loans: What is the difference? 

Now that you understand what a line of credit is, it might be confusing trying to compare the difference between a LOC  and a business loan product.

So, before we continue, let’s talk about it. 

While revolving credit is an open balance you can tap into whenever you’d like– provided you’ve paid the balance down– a more traditional installment or term loan is a single lump sum.

With an installment loan, you’re approved for a specific amount of financing, which you then turn around and begin paying off with installment payments. 

Once that loan is paid off, the transaction is finished and you’ll need to obtain another loan to get financing again. 

With a commercial line of credit, you borrow however much you’d like within your credit limit, repay that amount, and then borrow again. If you’d like to borrow a different amount next time, you can so long as it’s within your approved limit.

While installment loans tend to be larger sums for bigger one-and-done business purchases, such as equipment financing, they also have much less flexibility than a line of credit.

Ultimately, it all comes down to what you need financing for (which we’ll dive into in a moment). 

But first, let’s give you an example of how a business line of credit works. 

Business line of credit: An example

Jen, the owner of a rustic restaurant and bar in Texas, is approved for a $30,000 unsecured business line of credit. 

She needs $10,000 for renovations, but she also regularly needs financing for menu updates and cash to stock new ingredients before those items debut on the new menu.

Getting a business line of credit gives her the flexibility she needs to pay for those renovations, then after paying down the balance, use another $15,000 for further renovations and seasonal menu changes on a biannual basis.

Once Jen has repaid that $15,000 balance, she then has the full $30,000 available to her once again without having to apply for another loan.

What Is a Commercial Line of Credit Good For?

Unsecured Business Lines of Credit: Pros and Cons

We’ve touched on the utility and flexibility of  business lines of credit, but now let’s jump into specifics.

What are the pros of an unsecured business line of credit? Are there cons to weigh? 

Here are the pros and cons of a line of credit: 

Pro: You only pay interest on the funds borrowed

When you apply for an installment or term loan, you get approved for a specific amount. If the minimum is $20,000, but you only need $15,000, you’ll end up paying interest on the full $20,000.

However, with a business line of credit, you’ll only pay interest on the amount you draw from the credit line, saving you on interest and giving you flexibility on how to payback and take out more funds. 

Pro: Can be used for any business purpose

Many finance tools are specifically designed for a purpose and are restrictive in what they can be used for. That’s great if all you need is to replace a piece of equipment or put a down payment on a new property, but not ideal if you have a varied need for cash.

If you could use funding for several areas of your business, an unsecured business line of credit is likely much better suited for your needs.

Pro: Can be approved on bad credit

One of the biggest pros of an unsecured business line of credit is that you don’t need perfect credit to be approved. In fact, you can even be approved for a business line of credit with bad credit n some cases. However the business line of credit rates for bad credit applicants can exceed 3.5% per month.

If you can’t be approved for a bank secured line of credit (which requires collateral such as cash savings or property to secure the credit line), an unsecured business line of credit could be in your reach. 

Pro: A good way to build credit

Not only do you not need perfect credit to be approved for an unsecured business line of credit, because they can be used repeatedly, they’re a great way to build your credit. 

Each time you draw down your balance and begin making repayments, those payments are reported and help build your credit up so you have more borrowing power as your credit grows. 

Pro: Cash available whenever you need it

A line of credit gives you the flexibility to borrow the exact amount you need, so that you don’t have to pay interest on a larger amount. However, it also allows you to tap into that pool of credit whenever you need it.

Just got done repaying your balance? You can keep that credit line in your pocket for when a big order comes through, an emergency hits, or until your next busy season. You choose when to tap into your credit line, so the power is in your hands. 

Con: Lower credit score may result in higher rates

It’s important to keep in mind that because an unsecured business line of credit is exactly that, unsecured, rates tend to be higher than on secured loans.

Secured loans require collateral, hence that collateral “secures” the loan for the lender in case you fail to repay that loan and the bank needs to collect on what is owed to them. 

But with an unsecured business loan or line of credit, you don’t put down any collateral. That means if you default on your loan, you won’t lose any precious collateral.

With that said, the offset the potential loss, depending on your credit and business health, your rates may be higher than what you’d pay with a secured loan. 

Is a business line of credit a good fit for your small business?

With those pros and cons laid out, knowing whether or not a business line of credit is the right financing tool for you should be much clearer.

However, with that said, here are a few points that can help you decide whether you should consider a business line of credit vs. another type of business financing:

• Is your business seasonal by nature?
• Do you make regular cash-intensive updates to your business?
• Do you invest or pay large deposits for product or supplies before you’re ultimately paid on future sales?
• Do your customers pay on Net 30 or longer terms? 

If you answered “yes” to any of the above questions, an unsecured line of credit may be a good fit for your business. 

Having a good store of savings whenever your business needs it is ideal, but with the constantly shifting demands of running a business, that’s often very difficult if not impossible to maintain, especially for a small business. 

A business line of credit is the next best thing: a recurring source of capital you can borrow from– however much, and however often you need. 

How Is a Commercial Line of Credit Repaid?

With credit cards, you have the option to do minimum payments over the life of the account and accrue interest charges on the outstanding balances.

Generally, these minimum payments are at roughly $25.00 per month or based on a percentage of your outstanding balance.

However, a business line of credit works a bit differently.

Business Line of Credit Rates

How to Get a Business Line of Credit

5 Things You Should Know When Applying for an Unsecured Business Line of Credit

Here are 5 things you should know about an unsecured lines of credit:

1. They’re different from the secured bank loans you’re familiar with (unsecured vs. secured lines of credit)

A traditional business bank loan, the only major type of business loan available to business owners until around the turn of the century, is typically secured.

A secured loan is one where some form of collateral is used to guarantee the loan amount to the lender.

Think of this way: You ask an acquaintance to borrow $100 of which you promise to pay back within 30 days (your specified repayment date).

However, while this acquaintance knows a bit about you– maybe they’re a coworker– they don’t know you well enough to take you at your word alone.

They require something to make sure that, even if you weren’t to pay back the loan, they wouldn’t be out $100. So, you let them hold onto something of yours that is of roughly the same value.

This is loosely the same thing a lender does.

They will run a credit check, (some will be a soft check and some institutions might do a hard credit inquiry) study your business bank statements, and the like to mitigate their risk, but they’re a business. So, they need a way of guaranteeing they’ll get the money back that they’re lending.

And that’s where the secured part comes in.

A secured loan uses collateral to secure the remaining loan balance in the event that the borrower can’t pay back the loan. This collateral can be cash savings, property, vehicles, or anything else relatively liquid.

However, an unsecured loan doesn’t require traditional collateral.

It may require a percentage of future invoice sales, a kind of “soft” collateral. But if your business closes down, you’re not on the hook for the remaining balance. (Whereas you’d lose the collateral you put down in the case of a secured loan.)

2. Pay attention to fees

All financing products have fees. However, it’s important to understand that because a line of credit (or simply LOC) works differently from other types of loans, some of the types of fees are a bit different as well.

One of the more unique fees subject to a business line of credit as opposed to a traditional loan is a transaction fee.

Most lenders will charge what’s called a drawdown fee each time you draw from your line of credit. (At Excel, we do not have drawdown fees.)

In some cases, a maintenance fee may also be charged as well by the lender in exchange for their continued maintenance of your line of credit.

3. Is it a variable or fixed interest rate?

Many loans offer a fixed interest rate, some a choice between fixed or interest.

However, typically, a line of credit uses a variable interest rate which is a percentage of and fluctuates based on the prime lending rate.

Most unsecured business credit lines carry a fixed cost of capital that accrues monthly and carry a higher overall rate.

Secured lines of credit that are backed by property typically come with a variable interest rate due to the lower overall rate.

It’s important to consider what your lender is charging you in terms of interest on their business lines of credit.

Use that information when considering who to work with and how much you’ll pay in interest with a line of credit vs. something like a short-term business loan.

4. You can use a line of credit as many times as you’d like (provided you pay off the balance)

A business line of credit is unique among lending vehicles, so it’s sometimes misunderstood.

As opposed to being a one-time sum of money that is repaid at a specified interest rate, a business line of credit can be borrowed from repeatedly.

Provided you pay off the balance of the line of credit, you can use it again, pay it off, and use it again.

This makes it entirely unique among business financing vehicles. And it’s specifically useful for businesses that consistently need cash for investing in supplies or creating product long before obtaining a return on investment.

5. The Small Business Administration (SBA) offers several types of secured and unsecured business lines of credit

One of the SBA’s most popular lending programs is the SBA CAPLines programs.

The SBA’s CAPLine program is a collection of several business lines of credit, each with their own terms and conditions (typically offered through their flagship 7(a) loan program but can be offered as a standalone LOC).

The SBA CAPLines program offers these LOC programs:

1. SBA Seasonal CAPLine: For seasonal businesses, whether it’s pay for supply or making additional hires before a busy season.
2. SBA Contract CAPLine: Used to pay for labor and material costs with assignable contracts.
3. SBA Builders CAPLine: Capital for contractors to build and/or renovate residential and commercial real estate.
4. SBA Working Capital CAPLine: Gives businesses the ability to use short-term assets (invoices, etc.) to get working capital.

Lastly, keep in mind that the SBA doesn’t offer unsecured business lines of credit directly.

Instead, they match small business owners with lenders through their Lender Match program, helping them secure the funding they need.

Learn more about the SBA’s CAPLine business line of credit program.

Apply Today for a Business Line of Credit with Excel Capital

An unsecured business line of credit isn’t just the most flexible form of small to medium business financing.

With no collateral necessary there’s little risk involved for you as the business owner as well.

But an unsecured business line of credit isn’t for everyone.

Maybe you’d prefer a lower interest rate in exchange for collateral. Or maybe you need a larger single sum (which an unsecured business loan can fill the role of) of capital.

Whatever the case, now you know what an unsecured business LOC has to offer and how it can help grow your business.

And the more informed you are, the smarter choices you can make to keep growing it.

Get the capital your business needs– fast. Apply for a business line of credit with Excel Capital: Apply Now