What Is a Line of Credit and How Does It Work?

When researching alternative financing vehicles for your business, you may come across lines of credit. You can’t expect to grow your business without financing. All businesses require financing in the form of capital. Rather than applying for a loan, though, you may want to consider a line of credit. Both loans and lines of credit are forms of debt-based financing, but the latter vehicle offers a few key advantages. What is a line of credit exactly, and how does it work?

What Is a Line of Credit?

A line of credit is a financing vehicle that involves the use of a revolving credit account. They are offered by banks and alternative lenders. Whether you need capital to purchase new equipment, hire employees, restock inventory or launch advertising campaigns, you may want to use a line of credit. It will provide your business with a revolving credit account from which you can borrow money.

How Does a Line of Credit Work

A line of credit is similar to a credit card. After getting approved for a line of credit, you’ll be able to borrow money from the revolving credit account. You can continue to borrow money from it as long you stay within the lender’s predetermined limit.

All lines of credit have a limit. Some of the smaller lines of credit offered to small businesses may have a limit of $10,000, whereas larger lines of credit may have a limit of over $1 million. With a line of credit, the lender will provide you with a revolving credit account up to this limit. You can make payments to the lender so that your balance lowers and, thus, frees up more available credit.

Should You Choose a Line of Credit?

You might be wondering whether a line of credit is the right financing vehicle for your business. Many business owners prefer lines of credit over loans because it doesn’t have a fixed limit. Lines of credit still have a limit, but they are revolving. You can continue to borrow money from a line of credit as long as you pay down the balance.

As a form of debt-based financing, you’ll typically need good credit to obtain a line of credit. If you have bad credit — or if you don’t have any credit — you may struggle to get approved for a line of credit.

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