Line of credit overview
What is a line of credit?
A line of credit is a loan facility that can readily be drawn down or repaid back at any time within a pre-determined limit. This key feature means a line of credit behaves much like a credit card or an overdraft, but rather than being linked to a card or a bank account, it is its own standalone facility.
Like a credit card or an overdraft, interest is only charged on any amount that is drawn and the funds can be drawn down or repaid back at any time.
Given a line of credit is a standalone facility, there are a wider number of lenders who are able offer line of credit facilities to businesses when compared to a credit card or an overdraft.
Benefits of a line of credit
The key benefit of a line of credit is the flexibility it can give your business. It is fantastic having the peace of mind in knowing that you have funds at the ready to be drawn to help smooth out working capital ups and downs and taking advantage of new growth opportunities that may pop up. With a line of credit, you only pay interest on the funds you use too.
Given the nature of line of credit facilities there are a greater number of lenders with line of credit offerings out in the market. This means there is much more scope to shop around and find the lender that provides the best terms or the facility that best suits your business.
Drawbacks of a line of credit
Line of credit facilities can all come with very different terms, so be sure to understand and be across all the terms and conditions of any line of credit you are applying for.
The key things to look out for are the fees for the line of credit facility and then the usage terms. For example, some lenders may only charge interest and no upfront or establishment fees. Some other facilities may let you access the funds electronically once per day.
Line of credit facilities can come in both secured and unsecured forms. If security or collateral is provided to back the facility, this will help you get a lower interest rate, however may not be ideal if you don’t want to have any assets locked up as collateral.
Applying for a line of credit
Applying for a line of credit is similar to applying for most other loans in that you likely have to provide business bank statements in addition to business financial statements.
When applying for a line of credit be sure to ask for any application fees (if there are any) as well as if there are any other ‘facility fees’. This could include an ongoing fee charged by the lender for having the fund ‘in reserve’ for you in the form of the line of credit. Be sure to always ask for a thorough explanation of all of the terms and conditions included in your line of credit agreement too.
What is the best way to use a line of credit?
Line of credit facilities are best kept as reserve funds to help smooth out the ups and downs of cash flow over time. Whether the funds are used to pay for unexpected expenses or fund a new growth opportunity, that is entirely up to you. The only thing would be to be careful of where your limit is and to only use the line of credit when you are comfortable that you will be able to pay back the amount you draw down in the future so you aren’t stung with large interest bills.