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Is a business line of credit an option if I need loan finance?
It is an option for borrowing money, although it’s not a loan in the traditional sense – rather, it’s one of the various forms of business credit. A line of credit is an amount of funds that your lender has set aside to be available for your small business. This money can then be used as you have need and repaid when you have funds available.
If your business has a line of credit set up, it can provide incredibly fast and easy access to extra funds from a lender, without any need for loan applications or paperwork. It’s much more like a credit card than a loan.
The most significant drawback of a line of credit, however, are the interest rates – which are generally a fair bit higher than the rates you’d get on a business loan. This means that while it’s a good choice for covering sporadic, short-term expenses, it’s not an ideal solution when it comes to long term lending – so it’s not an ideal substitute for a business loan.
How does a business line of credit compare to traditional loan finance?
There are a number of key differences between a line of credit and traditional loan finance, each of which can make them a better or worse choice for a small business.
- Provides funds at need – One of the great strengths of a business line of credit is how easy the funds are to access. There’s no approval or application process – the funds are simply available for you to use them as you need them. But unlike borrowing a lump sum with a business loan, you’re only paying interest on the money you’re currently using.
- Can be repaid / cleared whenever you choose – Unlike many traditional business loans (which can often charge fees for early repayments), there’s no restrictions on repaying what’s owed on a business line of credit. You can pay the money back – up to the full amount – as soon as the funds are available, without any fees for doing so.
- Impacts credit more directly – One downside is that a business line of credit has a much more direct impact on your business’s credit rating. The application process for a business loan will put a slight dent in your credit rating, but after that it only really has an impact if you start missing repayments. Credit facilities like a line of credit have a much more direct connection with your credit rating, and having a large amount owing on a business line of credit can have quite a negative impact on your credit score.
In general, a line of credit is best suited to short term expenses (unexpected or not) which are paid off relatively quickly. For any large, long-term expense, you’re generally better off looking into traditional loan finance.
If you decide that a business loan is the way to go, Savvy’s a great place to start your hunt. On the Savvy website you can compare a variety of loans from a range of top Australian lenders, and find one suited to your business.
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Top tips for using a business line of credit well
Frequently asked questions about business lines of credit
How does a line of credit compare to a business overdraft?
There are many similarities, but the key point of difference is that while a business overdraft is a facility added to an existing bank account (allowing you to keep withdrawing funds once your balance goes into the negative), while a line of credit is a separate account. This means a business overdraft can be more convenient as it uses your current accounts. But it can also be a lot easier to lose track of spending.
What happens if you spend more than your limit on a business line of credit?
Generally, you’ll get a substantial fee and it ‘ll likely be noted on your credit record. It’s a good idea to avoid this if possible
Does a business line of credit cost anything when I'm not using it?
Many lenders do charge a fee on a line of credit that’s not in use – to cover their administrative expenses keeping those funds in reserve for you. The fees vary between lenders, so it’s worth checking what your lender charges when setting up the line of credit in the first place.
Should I look at an inventory finance line of credit for my business?
Inventory finance, or floorplan finance, is another option available to businesses who wish to take advantage of a line of credit in helping them add flexibility to their current stock purchase arrangement. With inventory finance, a business applies to have funds released to their supplier, who in turn fulfils their order and ships the required stock. Once the business is able to sell their product, they can then repay their lender. This is a line of credit which can remain open as long as it remains viable.
Are business lines of credit secured or unsecured?
They can be either. By default they’re often unsecured, but many lenders also allow you to arrange one of your assets to act as collateral on a business line of credit, often improving both your interest rates and your credit limit (if you want that extended – many small businesses prefer to deliberately limit their available credit).
Are there restrictions on what I can use a business line of credit for?
Business credit is incredibly versatile, and can be used for almost any business purpose – you don’t actually need to tell your lender what the money is for with a line of credit. Although it’s not generally regulated, you should still be using it for business purposes. Otherwise, you’re likely violating the terms of your agreement with the lender.
If I'm struggling to pay off my line of credit, can I transfer the debt to a loan?
Yes, this is quite common. It’s also not unusual to take out one loan to clear a number of debts, including a line of credit. This is called debt consolidation, and is normally a pretty good idea – you can generally get better rates on a loan than on a line of credit, so you’re lowering the overall cost of the debt. It’s best to be clear with your lender that this is the purpose of the loan, as lenders can be wary of offering an additional loan to a business with multiple outstanding debts.
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