5 questions to ask before taking out a business line of credit
Ask before taking out a business line of credit
- How does my business qualify for a line of credit?
- What's the credit limit?
- What documents and procedures are required?
- How long will it take to obtain the line of credit?
- What are the interest rates and fees?
Once establishing that a business line of credit is right for your company and the type of line appropriate to your situation, it’s time to shop around for a lender. With five key questions, you can assess whether the option makes sense for your business objectives and get the ball rolling toward opening your credit line.
1. How does my business qualify for a line of credit?
A lender will determine your company’s eligibility for a business line of credit depending on the following factors.
- Credit. You will be required to provide a credit report for the business. In addition, some businesses, particularly small or new companies, also may be required to provide the owner’s personal credit score. You will need a FICO credit score of at least 600 to be considered for a business line of credit. Many banks require an even stronger credit scores — at least 680 or higher.
- Time in business. Most lenders will want to see at least two or three years of business history. Online lenders may approve greener companies, but in return will seek higher interest rates.
- Revenue and financials. Lenders will calculate your business’ financial ratios — typically the working-capital ratio, which is current assets divided by current liabilities — in order to determine the fiscal health of your company. The more liquidity a company has, the higher the credit line lenders are willing to extend.
- Collateral. If you are seeking a secured business line of credit, the lender will require short-term assets, such as invoices and inventory, to be pledged as collateral against the line. Occasionally capital assets, such as real estate and equipment, are used as collateral.
2. What is the credit limit?
Your business may meet the lender’s qualifications, but does the line of credit meet yours? Calculate how much money your company needs and ensure that the proposed line corresponds with those requirements. Consider your future business plans as well as the business’ spending behavior. Will you realistically be able to manage a credit line far above what the company can afford to repay? Will the business require a larger credit line in the immediate future?
3. What documents and procedures are required?
Depending on the type of business line of credit, your company will be required to provide documentation demonstrating that it is in good financial standing and capable of taking on debt obligations. This can often involve preparing significant detailed paperwork, so it is important to determine ahead of time if it makes sense to invest the time to go through these procedures.
Traditional unsecured loans require the most paperwork, including proof of business registration, time in business, revenue, bank account information, and personal and business tax returns. Oftentimes, the approval process also requires the production of annual financial reviews and a reassessment of creditworthiness.
4. How long will it take to obtain the line of credit?
The length of the approval process is normally a function of how long it will take for the required documentation to be processed and approved. Online lenders tend to issue lines of credit faster than brick-and-mortar banks, and nontraditional unsecured business lines of credit (i.e., credit cards) are approved faster than traditional unsecured ones, sometimes within days.
5. What are the interest rates and fees?
Interest rates on business lines of credit are based on the owner’s FICO credit scores and other credit-rating measures. Contrary to business term loans, business lines of credit typically have variable interest rates tied to the prime rate. Brick-and-mortar banks offer the lowest interest rates, but are often the hardest lines to qualify for. While online lenders seek higher interest rates, some nontraditional unsecured lines in the form of business credit cards offer a zero percent interest rate for a fixed period. In addition to the interest rate, identify any up-front or annual fees associated with the line, as well as draw fees charged when the credit line is used.
Bonus Question: Can my business afford this line of credit?
You should ask yourself this question before considering taking out a business line of credit and even after your potential lender determines your eligibility. Carefully compare the credit limit, terms and rates of the prospective line of credit with your business’ revenue schedule and objectives before accepting the option. After all, the line of credit should be an asset to your company, not a liability.