What are the benefits and drawbacks of a line of credit?

Running into cash flow issues from time to time is part of the process of running a new business. Sales growth is never orderly and can occur in spurts. These inconsistencies can be challenging to manage and usually have you cash-strapped, without sufficient money to expand the business and pay suppliers. When companies run into cash flow issues, most owners apply for a business line of credit. Having a credit line offers several benefits and drawbacks, which must be carefully considered to determine if this financial product is best for your budget.

The benefits of a business line of credit

Working capital is expressed as your current assets you deduct your present liabilities. Simply put, it is the money (or cash equivalents) that your business has, deduct your short-term debt obligations.

As a business owner, you will have times when working capital is tight, which can be a real issue. Working capital allows you to operate your business, enabling you to maintain inventory, afford payroll, and pay for other consistent costs such as rent and utility bills. Let’s outline some of the benefits of a business line of credit to your small business.

A business line of credit is often cheaper than using a credit card

Businesses and households can appreciate the benefits of having a credit card for immediate spending needs. The only issue with a credit card is that it will often carry a large APR. Some consumer cards come with a standard APR of 29.99 percent. If you can be accepted for a business line of credit, then the interest rates are often lower than what you would find with a similar credit card at the same credit score. You will have the same purchasing power and be required to repay less over time.

Evens out cash flow during slow seasons

For most businesses, a line of credit is the ideal resource for balancing cash flow. Of course, this is more applicable to some businesses than others. For instance, a retail store that makes most of its sales during the holiday season might be short on cash during other times throughout the year, making it hard for them to make payroll. As a result, you cannot use a credit card to pay your staff, a small business line of credit is the sensible solution for this type of business.

Enables you to pay for what you use

Once you receive a credit line, you only pay interest on the amount that you use. Also, based on the agreement with your lender, you might be able to clear the balance at any time without a prepayment penalty.

It minimizes the temptation to buy unnecessary items

From a consumer perception, the availability of credit cards, together with its ease of use at the point of sale, makes it a temptation to buy items that are not required. From a business perception, the spending on a credit card can have a tax advantage, which creates a temptation to buy items. A business line of credit is usually linked to a banking account, which lowers impulse purchases for most individuals.

Improves business adaptability

There might be times in which you have a limited window to make excessive use of opportunities. For instance, let us say you are a manufacturer, and your supplier’s costs are significantly reduced. You will need to take advantage of that limited-time offer; however, you might not have the money to do it. With a business line of credit loans, you will not risk missing out on a great opportunity to save money in the long-run.

A business line of credit helps build business credit

Another positive aspect of a business line of credit is that it can help you build your business credit history. For example, to get the best terms (and avoid higher interest rates) on personal loans, you will require a long personal credit history. The same goes for business credit, and a commercial line of credit can be useful in this pursuit. If you would like to boost or maintain your credit score, receiving a business line of credit (and paying it off responsibility) can be a great way to attain this.

A line of credit makes money availability happen faster

Compared to other kinds of credit, a business line of credit can be processed in as little as twenty-four hours. Even for larger credit lines, the flip-flop for a line of credit is often a few days. For credit, it might be two to three weeks from the beginning of the application process. If you are dealing with a home equity line of credit for your additional cash flow, you may be waiting several months to have your availability.

It is normally an unsecured line of credit

Most of the time, a credit line is an unsecured loan that can be utilized at your discretion. That is another comparability it has to the standard credit card. In the event you default on a debt for some reason, since it is unsecured, you are at very low risk of losing essential assets. Your credit will take a hit for seven to ten years with a default; however, for some, that will be better than losing a home, car, or the building where your business is operating.

The price of setting up a business line of credit is often low

The initial cost of setting up a credit line is often similar to that of having a credit card. Some might even be free. Like an annual fee or a credit card, most credit lines have a yearly maintenance fee of $100 or less for the average consumer. When it comes to six-figure credit lines may have a higher maintenance fee. Provided you do not use the line of credit for a particular period, usually 12 months or more, then another fee might apply to the account. Otherwise, you will find that it does not cost much to access the money you need for short-term issues with this lending product.

List of drawbacks of a line of credit

Drawbacks of a line of credit

A line of credit has a higher interest rate than other lending options

A business line of credit is usually cheaper than the average credit card. It is also liable to have a higher interest rate than a home equity line of credit or a secured credit line. That is because you are dealing with different layers of risk. If you have a secured loan, then you are providing a guarantee to the lender. In the event you default on a secured debt, then what you used for collateral can be claimed by the lender even though you put your house up for security.

A line of credit operates under various regulations

Credit cards are regulated more strictly compared to a line of credit. You will want to ensure that you check on all the fees that may be charged when you create a new account. You should check to see what penalty fees might apply. There might be additional charges for going over your credit line, not accessing your credit line, or making a late payment. This is another place where you will require to spend a lot of time comparison shopping to guarantee that you are getting a good deal. 

The fees for a business credit vary widely all through the industry

Once you apply for a line of credit, you will realize that the maximum amount permitted, interest rates, and other variables with this lending product will widely vary. You are forced to shop around with several different lending institutions to see what types of deals are available to you. That indicates every application you submit generates a hard credit pull, which will negatively affect your overall credit score if you have sufficient of them.

Almost all lines of credit have an adjustable interest rate

Typically, there are some types of lines of credit that have a fixed interest rate. If you find one, stick with it, that is if the deal is fair. This is because most lines of credit have an adjustable interest rate. That indicates the lender is permitted to increase your APR in the future, which indicates your payments will go up anytime that happens. With a business line of credit, a rate increase applies to the new charges and existing balance, which indicates a hefty increase might make it possible to meet your monthly payment obligations. Always make sure you look to see how the interest rate can be adjusted, and by how much, before taking on the line of credit.

You might still be tempted to overspend with a business line of credit

A line of credit may not provide the same temptation to spend that a credit card offers, even though that does not mean the temptation disappears. For business owners who struggle with spending and tend to maximize out their business and personal credit cards, then a line of credit might not be the right choice to make. You might find yourself maxing out another credit line, creating even more debt obligation to manage in the future.

The benefits and drawbacks of a business line of credit make it possible to stabilize the business and personal finances when there are emergencies or unpredicted lapses of income. Similar to any lending product, there are various options available in today’s marketplace. Some will have a positive effect, and others will not. It is up to you to do your own due diligence to make sure the business line of credit you choose can maximize your finances’ power.

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