What is a Business Line of Credit?
A business line of credit is, like any other credit line, a revolving loan wherein you can withdraw and pay down funds cyclically. There’s no obligation to use the full amount, and interest is only ever charged on funds withdrawn. Lines of credit can be secured (backed by collateral) or unsecured (though, for businesses, secured lines are standard). Interest rates on credit lines are typically lower than those found with traditional loans, though they are, in most cases, variable, changing in step with the lender’s prime rate. The interest rate your business will receive on your credit line is determined by your perceived creditworthiness, a valuation derived from your business’s credit score, credit history, and revenue stream. There are many benefits to utilizing a line of credit as a business; if revenue fluctuates over time, as it would with a seasonal business, a credit line can help stabilize payment schedules for payroll and other expenses. When income is slow, you withdraw, when it picks up, you pay down. Likewise, businesses may want to consider maintaining a line of credit to preempt large, unexpected expenses or to be able to capitalize on surprise investment opportunities.
Interest rates vary based on a business’s creditworthiness and ability to put forth collateral, but generally speaking are lower than those offered by traditional loans. Lenders calculate interest rates by adding a margin, a set amount determined by the applicant’s credit score, revenue, and the like, to the lender’s prime rate, the lowest rate at which money would be lent at a given time. Prime rates fluctuate, and therefore so do interest rates on lines of credit, which is an important differentiating factor between credit lines and traditional loans with fixed interest rates.
As with any loan, each lender has their own established criteria for which businesses are eligible to receive a line of credit, and on what terms. For business lines of credit, there are some commonalities across the lending market. First and foremost, most lenders won’t lend to an entity that hasn’t been operating for at least two years, although sometimes exceptions are made for start-ups or other new ventures if the owner(s) has solid financial standing. Although some lenders award credit lines without collateral, in the world of business lending this is exceedingly rare. Most business lines of credit require equipment, real estate, company bank accounts, or other valuables to be put forth as collateral. In some instances where the offered collateral was purchased on credit, the lender of the line of credit might ask the loan recipient to consolidate their debt with them, giving them first priority in case any property needs to be repossessed. It’s also worth noting that lenders frequently ask businesses to put up all their assets as collateral. Perhaps more obviously, lenders will look at a business’s revenues and profits in deciding their eligibility for a line of credit. In most cases, a business must have verifiable revenues and profits in order to be eligible for a line of credit. This analysis involves reviewing specified ratios present within a business’s financials, such as debt to equity. Finally, most lenders will ask for personal guarantees from the company, parents companies, or owners and shareholders to ensure that the loan(s) will be repaid.
Businesses that have never borrowed, or those that are relatively new to an industry, will often times not have the kind of established credit history lenders have come to expect when performing an in-depth credit check as part of a line of credit application. To help lenders feel less at-risk when lending, then, it’s common practice to ask for personal guarantees from business owners that a given loan will be repaid. Corporate law is structured such that owners aren’t liable for their business’s debts or legal troubles, which makes a personal guarantee highly valuable to a lender. Personal guarantees are avoidable, but usually only if collateral is being offered in its place.
What if I Have Bad Credit?
The favorable terms usually associated with business lines of credit make qualifying for such lines challenging. Thankfully, for individuals or businesses with poor credit, there are some alternatives. One good option to consider is an asset-based loan (ABL). An ABL is a loan where some or all of a business’s assets are financed, or re-financed, via a new lender. Most ABLs are structured similarly to credit lines in that they function as revolving loans. Of course, as with every alternative available to those with poor credit, interest rates will be higher than those found on lines of credit. Another option to look into would be an SBA Microloan. SBA Microloans (loans up to $50,000 brokered by the Small Business Association) are significantly easier to obtain that lines of credit and may be just the quick-fix option your business needs. Finally, seeking a line of credit at a credit union might be worth exploring. Credit unions, as cooperative, not-for-profit enterprises, tend to be more understanding of the circumstances that leaves one with poor credit and may be more willing to lend on your word and the strength of your character.
No Credit Check
Applying for a line of credit without a credit check, referred to as a stated income or ‘no doc’ loan (applicants aren’t required to provide any documentation proving their revenue), is an option that, though feasible for those with poor credit, leaves the applicant open to exploitative lending. Still, they are attractive, as traditional credit line applications can take upwards of 30 hours to complete, and are rejected (when unsecured) somewhere around 90% of the time. These lines of credit are rarely offered by large financial institutions. The marketplace for stated income loans is dominated by a diverse array of online lenders. On the upshot, the applications processes are nearly instantaneous, as they involve little more than linking your corporate bank accounts to an app, whose algorithms analyze your financials. The downside is, of course, that interest rates are significantly higher than what a traditional bank would offer. If you choose to pursue a stated income loan, please be wary of predatory lenders, and perhaps seek financial counsel from a professional to weigh the many options at your disposal.
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Unsecured vs. Secured Lines of Credit
All loans are by default unsecured. A secured loan is a loan whose eventual repayment is guaranteed by the recipient having offered significant collateral in exchange for the loan. In the context of a business line of credit, lenders will often ask that all assets be put up as collateral for a credit line, although they occasionally extend lines of credit with only real estate, equipment, or bank accounts used as collateral. Banks and other traditional lenders deny roughly 90% of applications for unsecured business lines of credit. In a lending marketplace so unfriendly to those with poor credit, it’s more than understandable that businesses turn to stated income, or ‘no doc,’ loans, wherein the lender doesn't require any proof beyond the applicant's word regarding their entity's financials. The trouble is that the marketplace for these risky loans is dominated by predatory lenders whose loans frequently come with hidden fees and exceedingly high-interest rates.
Above, under the ‘Bad Credit’ and ‘No Credit Check’ headings, we’ve outlined some alternatives for individuals in this position. If you intend on pursuing a line of credit for your business despite having bad credit, be sure to be honest in your application, humble in your approach, and reasonable in your expectations. Lending agents may just give you the time of day if they sense you are earnest and that you have a solid plan for both the future of your business and for rebuilding your credit.