Five Types of Business Line of Credit, From Secured to HELOC
A line of credit is an arrangement between a financial institution, usually a bank, and a client, in which the amount the customer can borrow is established. The borrower can take money out as needed until the limit is reached, and as money is repaid it can be borrowed again. The borrower must stay within the credit limit and meet other requirements such as maintaining creditworthiness and making timely minimum payments. Some credit lines allow you to write checks while others include a credit or debit card.
Businesses can use a line of credit to finance short-term working capital needs such as bridging a seasonal cash-flow gap, repairing business-critical equipment or financing a marketing campaign. There are five types.
1. Secured business line of credit. The business pledges specific assets as collateral. Because this type of 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 assumes ownership of the collateral and sells it to pay off the balance.
2. Unsecured business line of credit. No specified assets are demanded, but a personal guarantee is likely needed. The business will most likely need a more robust credit profile and a positive track record, and interest rates may be slightly higher.
3. Revocable line of credit. This can be rescinded at the lender's decision or under specific circumstances.
4. Securities-backed line of credit. Loans are secured by the borrower's investment account. Typically the borrower can borrow anywhere from 50% to 95% of the value of the assets in the account.
5. Home equity line of credit. Secured by the equity in the borrower's home. The amount owed must be less than that equity. Lenders like it because it offers a way to recover funds if they are not repaid.
On the plus side, a line of credit is scalable to manage cash flow and seasonal needs. On the minus side, watch for maintenance and withdrawal fees, the temptation of immediate cash, and a bank requirement that your business be two years old.