How Does a Line of Credit Work and How Can You Get Approved?

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When small business owners need access to financing, they will often start with a bank or credit union, and apply for a loan. If funding for their small business (in the form of fixed or variable rate loans) is not easily available, some may even try to bridge the gap with personal loans. However, in many cases, a line of credit is the best alternative.

Unfortunately, banks and credit unions have strict application processes that involve providing a lot of documentation. Being approved can also take weeks (or months), and require minimum credit scores that prove to be too high a bar for some. Online lenders, such as Merchant Growth, cut down on the waiting time and documentation, and are also more flexible. 

If small business owners want to stay out of financial trouble, they should speak with an experienced lender to gain a greater understanding whether or not working with large financial institutions is the best choice for them.

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What is a Line of Credit?

Both financial institutions and alternative lenders offer secured and unsecured lines of credit, which are essentially used like a regular credit card. You can borrow, pay some back, take more out, and access financing on your schedule, based on your specific needs. 

Because you don’t need to re-apply for financing every time you need more, lines of credit are often referred to as “revolving credit.” You can use any amount within the limit, and there isn’t a deadline for repayment; you simply pay interest on the amount you borrow along with a minimum payment each month. Some financial institutions may charge fees for registration or administrative work. 

When Should You Use a Secured or Unsecured Line of Credit?

A secured line of credit requires an asset to be used as collateral, on the off chance that the borrower can’t repay the money. One example of a secured line of credit is a home equity line of credit. It has a higher credit limit and lower interest rates compared to other lines of credit. Traditional lenders are more willing to offer secured lines of credit because there is less risk involved for them compared to an unsecured line of credit. 

As you would expect, an unsecured line of credit is where the borrower does not need to provide collateral in order to receive funds. Some examples of this line of credit include personal lines of credit and student lines of credit. 

A personal line of credit can be used to consolidate higher interest rate loans while a student line of credit is often used for post-secondary education expenses. For businesses, some unsecured lines of credit come with a lien included, where the lender has the right to claim business assets if the borrower falls behind on payments.

The question: Is a line of credit worth it for your business?

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What Are the Pros and Cons of a Line of Credit?

Small businesses benefit from flexibility since the funds can be used for a variety of purposes:

  • Inventory Purchases
  • Cashflow
  • Technology Upgrades
  • Unexpected Expenses

A line of credit is ideal for businesses that require capital, but don’t substantive lump sums for larger projects. Funds from a line of credit will always be available, saving you time from reapplying like with other loan products.

Unlike personal loans where you are given the money needed in one lump sum, lines of credit allow for a gradual disbursement of funds, so businesses use only what they need at that moment. They also only pay interest on what they have borrowed at the time. 

Business lines of credit can be cost-effective solutions for monthly needs, as long as there isn’t excessive spending and the owner makes regular monthly payments. (Keep in mind that paying only the interest will mean that your business will be in debt longer.) With a line of credit, you won’t be charged interest until you have an outstanding balance. 

Like most financial vehicles, a line of credit has its advantages and disadvantages. How and when it’s used is a major determining factor in its usefulness. Before you accept any terms and borrow money, carefully review the terms and conditions, the interest rates, and the repayment schedule. 

Ask your lender as many questions as you can think of to ensure you’re working with an experienced and trustworthy financial institution.

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Is it Hard to Get Approved for Line of Credit?

Sometimes it is, yes. It can be harder to get approved for a line of credit with traditional lenders like banks, as they follow a strict process and have requirements that some businesses find burdensome. 

When applying, you don’t have a choice about the credit limit. The lender will review many aspects of your personal and business affairs as a way to determine a suitable credit limit.

How Does a Lender Determine Your Credit Limit?

Many lenders will review your credit history, personal and business credit scores, and gross annual income level. In order to qualify for a line of credit, most lenders have minimum requirements. This often means business must be in operation for at least a year, which makes it difficult for startups to access this type of funding early on. 

A traditional financial institution usually reviews your credit score, and many lenders require a score around 660. But that’s where online lenders become a better alternative, as some of them don’t use the credit score as a qualifying factor.   

While you don’t get to choose your initial credit limit, borrowers who exhibit a good financial standing and responsible usage of their line of credit will be given the opportunity to increase their limit. Lenders may inform the borrower that they qualify for a higher limit or the borrower can ask for one after a certain amount of time.

Getting a business line of credit is easier with Merchant Growth. 

Need to Borrow Money? Partner with Merchant Growth!

Merchant Growth’s minimum requirements for a line of credit are simple:

  • Your company must be in business for at least six months.
  • Your business must be located in Canada.
  • Your monthly revenue must be 10K.

If businesses already use our Fixed Financing solution, we can also provide them with a line of credit if it suits their situation. 

Speak with our financial advisors, or apply now!

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