Understanding Business Lines of Credit

How a line of credit works step by step

You are approved for a limit, draw funds when needed, repay over a set schedule, and the repaid amount becomes available again during the draw period.

Say you are approved for a $100,000 line. Nothing is owed until you draw. If you draw $30,000 for inventory, your available credit falls to $70,000, and you pay on the $30,000. As you repay $10,000, available credit rises to $80,000.

1. Approval. The funder reviews your revenue, time in business and credit and sets a limit.
2. Draw. You request funds, often online, and receive them in your business account.
3. Repay. Payments are made weekly or monthly, depending on the product.
4. Redraw. Repaid amounts can be borrowed again while the line is active.

Many lines have a draw period followed by a repayment period, or an annual renewal. Read the agreement to see which applies. Our page on the business line of credit gives product details.

What a line of credit costs

Costs may include interest or a fee on drawn amounts, plus origination, draw, maintenance or renewal fees. Compare total cost on the amount you expect to use.

Different lines price differently. Some charge interest on the outstanding balance. Others charge a fixed fee per draw that is repaid over a set term. Fees can include an upfront fee, a draw fee, an annual or monthly maintenance fee and a late payment fee.

Because pricing varies, look at the total dollars repaid for a typical draw. In this illustrative example, you draw $20,000 and the total repayment over six months is $21,800. The cost is $1,800, or about $300 a month. If the inventory you bought earns $5,000 of profit, the line paid for itself. Our guide to how interest works on a business line of credit explains the common methods, and what APR is helps you compare offers.

Secured vs. unsecured and personal guarantees

Secured lines are backed by collateral and often cost less. Unsecured lines rely on your credit and revenue. Many require a personal guarantee either way.

Collateral can be equipment, inventory, receivables or real estate. A lender with a blanket lien files a UCC notice on business assets; see UCC filings and business loans.

Even unsecured lines frequently require a personal guarantee, which makes the owner personally liable if the business cannot repay. Understand this before signing. Details are in business line of credit personal guarantee.

Ask these questions of any offer:

• Is it secured? By what?
• Is there a blanket lien?
• Do I need a personal guarantee?
• What happens if I do not use the line?

What the line is best used for

Use a line for short-term, repeating or uncertain needs: inventory, payroll gaps, supplier discounts, repairs and seasonal swings. It is a poor fit for long-term fixed assets.

Good uses include:

• Buying inventory ahead of a busy season
• Covering payroll while a large invoice is outstanding
• Taking early-payment discounts from suppliers
• Paying for an unexpected repair
• Starting a project before the client's deposit arrives

Poor uses include buying a building or a heavy machine you will pay off over many years, long-term losses and personal expenses. For fixed assets, equipment financing or a term loan fits better. See line of credit purpose for more.

Who qualifies and how to apply

Funders look at time in business, monthly revenue, credit and bank activity. ROI Funder considers 6+ months in business, $20,000+ monthly revenue and 500+ FICO.

What to prepare:

1. 3 months of business bank statements
2. A completed online application
3. Basic ownership and business information

With ROI Funder, the application takes a few minutes and uses a soft credit pull, so applying does not affect your credit score. There is no obligation to accept an offer. Lines of credit typically move in 24-72 hours on complete files. Learn what to expect in what to expect when applying for a business line of credit.

Limits depend on your file. For an idea of how much you might receive, read how much you can borrow with a business line of credit.

Using a line responsibly

Draw only for a planned purpose, repay on a schedule, and avoid treating the limit as free cash. Track the cost of each draw against the return.

The flexibility that makes a line useful also makes it easy to misuse. Habits that protect you:

• Write the purpose and expected payback of every draw.
• Repay from the sales the draw produced, not from the next draw.
• Keep balances well below the limit in case of emergencies.
• Review the statement monthly and watch for fees.

If the line balance keeps growing and never falls, the business has a profit or pricing problem that credit will not fix. Address it with your accountant. When used well, a line smooths cash flow, builds a record with funders and gives you room to say yes to a good opportunity. ROI Funder starts from the payback math and shows true cost, payback period and monthly-equivalent payments before you sign. Compare options on which funding fits your business.