Business Line of Credit

As a small business, you never know when you’re going to need fast access to cash. A slow paying customer, a sudden slump in sales or an unexpected expense could leave you with a shortfall in working capital, and no time to scramble for funding.

A business line of credit is a valuable facility that puts funds at the disposal of your business, without locking you into regular interest payments on borrowings you don’t yet need.

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What is a business line of credit?

A business line of credit is rather like an overdraft (except that the funds are available at any time, not just once you’ve spent all the money in your account). When you make a successful application for a line of credit (or ’LOC’) you’ll be given an approved credit limit, which is the maximum amount you can access under your facility. Until you draw down the funds you won’t pay any interest. When you need them, you can access the funds without the need for additional approval from your lender.

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Types of line of credit

Like with other forms of business loans, a line of credit can be secured or unsecured. A secured line of credit is likely to be less expensive (as it’s lower risk for the lender) but you’ll have to provide assets as security. Not all small businesses have collateral to offer, and in any case, you may not wish to tie up your assets in this way.

A line of credit could be a simple, one-time deal, in which the facility is made available, you draw down funds when you need them and then you repay the loan, paying interest until the balance reaches zero again. However, many businesses prefer a revolving line of credit, where you can draw down funds, repay them and redraw them as often as you need to, only paying interest (usually calculated daily) on the outstanding balance.

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Key differences between a line of credit and other business loans

The biggest advantage of a line of credit over a business loan is that you only pay interest on the funds you are using. You’ll have the peace of mind of knowing that funds are available, up to your agreed credit limit, whenever you need them – but until you draw them down you won’t be charged interest (although, as you can probably imagine, most lenders will charge a facility fee, to compensate them for the fact that they can’t earn interest on those funds by lending them to anyone else while they are committed to you).

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What will my credit limit be?

Like any form of business finance, the amount you can borrow will depend on a number of factors, including your credit rating, average turnover, regular expenditure and sales pattern. Each lender will use their own formula to assess your application and determine how much they are willing to lend you. Some lenders set credit limits as a percentage of gross revenue, while others will base their limits on your cash flow.

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Repayment Terms

Repayment terms, and all the other conditions of your line of credit, will depend on the lender and the specific product you apply for. Generally, a fixed line of credit will have a loan term of between 3 and 30 months – meaning that you can draw down the funds at once or in instalments at any time from the day your line of credit is approved, and must restore your loan balance to zero by the end of the agreed period.

If you are able to secure a revolving line of credit, there will be no fixed term, although the lender will review your facility from time to time (for example every 2 years). As long as the line of credit is in place your business can use, repay and reuse the funds as often as necessary.

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Interest and fees

The way you pay for a line of credit is the main difference between this form of business finance and other types of business loan.

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Application fees

Most lenders charge an initial application fee to set up a line of credit, which is often calculated as a percentage of your credit limit. You can expect to be charged between 0.5% and 3% of your approved credit limit – so for a $100,000 facility the application fee would be anywhere from $500 to $3000. There be a minimum fee if you’re seeking a lower credit limit.

Interest

The amount of interest you pay on your line of credit borrowings will – as with any form of business funding – depend on the lender and your business circumstances (i.e. the amount of risk the lender assesses that you present).
The main difference between a line of credit and a standard business loan is that although you have funds available when you need them, you generally won’t pay interest on the whole amount of the facility. Instead, you’ll pay interest (usually calculated daily) on any funds that you have drawn down. This gives you flexibility to act fast when you need cash, and peace of mind that you’ll have funds on hand to cover any shortfall in your working capital, without the expense of a taking out a short term business loan ‘just in case’.
However, once your draw down funds under your line of credit you will need to make regular interest payments – and the cost of your finance will quickly mount up if you only pay back the interest and don’t reduce the principal.

Monthly service fees

By offering you a line of credit the lender is committing to make funds available to you for an agreed period. During that time, they will not be able to earn interest on the funds that you do not draw down. To compensate them for the potential loss of income, some lenders will charge a monthly service fee for your line of credit.
These fees can vary widely, and it’s important to make sure there are no other hidden costs or charges before you commit. Be sure to compare the combined cost of both interest and fees when deciding which lender to choose.

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Line of credit requirements

As with most types of business loans, it can be tricky to secure a line of credit from a traditional bank unless you have a well-established business with a strong trading history, excellent credit rating and high average turnover. However, with the rise of the fintech loan market it is becoming far easier (not to mention faster) for SMEs to access line of credit facilities from alternative lenders.

While each lender will use their own criteria to assess your application, you can expect them to consider the following factors:

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How long you have been business

Your trading history is a good indication of whether your business is viable. Banks usually expect two to three years profitable trading, while non-bank lenders will often offer facilities to newer businesses (with six months’ trading history).

How much interest you can afford to pay

Above all else, lenders need to know that you have the capacity to service your loan (i.e. keep meeting your monthly payments). Although fintech lenders may have less strict criteria than the banks, even alternative lenders with a high risk tolerance need to know that you should be able to repay what you borrow. To assess serviceability, they will look at your profit and cash flow rather than your turnover.

Whether you have any collateral to offer

If you’re applying for a line of credit from a traditional bank, you will probably be expected to provide assets as security, up to the value of your credit limit. If, like many SMEs, you do not have property or plant and equipment to provide as collateral, you will probably need to approach an alternative lender for your LOC.

Many small businesses will qualify for an unsecured line of credit of up to $50,000, but few lenders, even in the fintech market, will offer a higher credit limit than that without some form of security.

In this instance, you may want to consider unsecured business loans.

Your credit rating

Some alternative lenders specialise in offering finance to businesses with poor credit ratings (usually with high charges to compensate for the increased risk). However, many lenders, especially banks, will not be willing to offer you a line of credit if your credit score is low.

Your income and cash flow

As a minimum you’ll need to provide six months’ bank statements as evidence of your income, regular outgoings and free cash flow. For traditional lenders, expect to be asked for two to three years financial records, including full financial statements and cash flow projections.

How you plan to use the funds

Any lender will want to know why you need a line of credit, as this form of business finance is a short-term facility which is unsuitable for capital purchases. In most cases, small businesses take out a line of credit as a buffer in case of income fluctuations, late-paying customers or emergencies like urgent equipment repairs.

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How to apply for a line of credit

If you’re hoping to secure a line of credit from a bank, you can expect to go through a lengthy and burdensome application process. You may need to meet face-to-face with a business lending specialist at the bank, and it can take weeks for an application to be assessed.

With alternative lenders, the process is often much more streamlined, with applications usually completed online, and often assessed within a matter of days.
Expect to be asked to provide the following documents:

Bank lender
  • Financial statements
  • Balance sheet
  • P&L statements
  • BAS statements
  • Tax returns
  • Business plan
  • Mortgage statements (if you own the property)
  • Lease agreement (if you’re renting)
  • Photo ID
Alternative lender
  • Bank statements
  • Photo ID

Speed, convenience and accessibility mean that more and more small businesses are turning to alternative lenders for line of credit finance, despite the additional cost. It’s important to seek independent financial advice to help you decide if a line of credit is the best type of funding for your business, and to choose the right lender and product.

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Line of credit – pros and cons

Pros:
  • Peace of mind – have funds on hand whenever you need them
  • Pay interest only on the funds you use, rather than the full credit limit
  • Simple and easy online application process with alternative lenders
  • Fast access to money – funds available within 24 hours of approval with non-bank lenders
  • Buffer in case of unexpected expenditure or working capital shortfall
Cons:
  • Peace of mind – have funds on hand whenever you need them
  • Pay interest only on the funds you use, rather than the full credit limit
  • Simple and easy online application process with alternative lenders
  • Fast access to money – funds available within 24 hours of approval with non-bank lenders
  • Buffer in case of unexpected expenditure or working capital shortfall

A line of credit provides ultimate flexibility and control, combined with the cost-effectiveness of paying interest only on funds you actually need. This makes it one of the most popular types of business finance for Australian SMEs. See how much a line of credit would be with our calculator.

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