Line of Credit: Borrow as Needed Up to Your Limit
A line of credit is an arrangement between a financial institution, usually a bank, and the client, where the loan amount the customer can borrow is established. A stipulated borrowing limit is given to the borrower, who can take money out as needed until the limit is reached. As money is repaid by the borrower, it can be borrowed again. The borrower has access to funds from the line of credit at any time, as long as he keeps within the maximum amount set in the agreement and meets any other requirements, such as maintaining creditworthiness and timely minimum payments. It is controlled by the amount of interest, size of fees and different lender rules. Some credit lines allow you to write checks, while others include a type of credit or debit card.
Businesses can finance short-term working capital requirements by using a line of credit, for example to bridge a seasonal cash-flow gap, repair business-critical equipment or finance a market campaign.
Types of business lines of credit: a secured line demands that businesses pledge specific assets as collateral. Because a line is a short-term liability, lenders ask for short-term assets such as accounts receivable and inventory. If the borrower cannot repay, the lender will take ownership of the collateral and sell it to pay off the balance. An unsecured line does not demand specific assets, but a personal guarantee will likely be needed, and the business will need a more robust credit profile and a positive track record; interest rates may be slightly higher. A revocable line can be rescinded at the lender's decision or under specific circumstances. A securities-backed line is secured by the borrower's investment account, typically allowing the borrower to borrow 50% to 95% of the assets' value. And a Home Equity Line of Credit is secured by the equity in the borrower's home.
The advantages: it is scalable to help manage cash flow, unique opportunities and seasonal needs; it gives the essential working capital; it has the flexibility to pay expenses and cover general purposes; and lenders judge credit decisions based on the company's financial strength, not just the owner.
The disadvantages: fees and extra charges, since lines of credit can result in a mountain of fees from maintenance and withdrawals, so ensure any added fees are justified. Debt acquisition: if there is a slowdown in business and the cash has been spent with no means to repay, you incur debt, and it is sometimes advisable to take a standard loan to avoid the temptation of immediate cash. And application hitches: your bank sometimes requires that your business is two years old.