What Type of Credit Line is Right for Your Business?

Female business owner researches types of credit lines for small businesses.

Business owners often find themselves in the tricky spot of having to keep up with their own bills or payroll obligations while they’re still waiting for customers to pay outstanding balances. In other cases, they might need to purchase new inventory or invest in marketing efforts in order to increase future sales. But it takes funding to manage these expenses before the revenue rolls in. And during uncertain economic times, that extra funding right when it’s needed can be especially crucial.

In cases like these, a small business line of credit can be critical. A business line of credit can help business owners make the investments they need to increase revenues and expand profits. For business owners with cash flow challenges or other needs for short-term capital, a line of credit can be a valuable solution.

To take advantage of this option, business owners need to understand how a small business line of credit works and the different types of credit lines that are available to them.

How Does a Business Line of Credit Work?

In most cases, a business owner will be approved for a line of credit up to a certain amount, similar to a credit card. If you’ve been approved for a line of credit and you need to access some of the available funds, you can usually make cash withdrawals via check or debit card.

After you have used some of the credit available on your credit line, you will be billed for monthly interest payments until the amount is repaid. When your customers pay up or your sales increase, it’s a good idea to work toward paying off the amount borrowed rather than simply continuing to pay interest. That’s because you’ll have less credit available the next time you need to use your credit line.

When the line of credit has been repaid, it will remain available for the business owner to use as needed.

Types of Small Business Lines of Credit

There are two main types of credit lines available for small business owners: secured and unsecured. A secured line of credit is guaranteed by a real asset that can be used for collateral. That might include real estate property such as your place of business if you own it, or your personal home. You can also secure a line of credit with other financial assets, such as Certificates of Deposit (CDs) or unpaid invoices.

On the other hand, an unsecured business line of credit does not require collateral. This type of credit line is used more commonly for small business lines of credit. That's because most small businesses rent rather than own their business locations and may not have adequate assets to secure a long-term line of credit.

An unsecured business line of credit is more widely available to small business owners, since the business owner does not have to put up collateral. And an unsecured line can provide funds for a wide range of needs, with thousands of dollars in funding typically available.

How to Use a Business Line of Credit

The main reason that business owners pursue a small business line of credit is so that they can get access to short-term funding. They can use short-term funding in a number of ways, such as covering expenses while waiting for customer invoices to be paid.

If you have a business line of credit, you can use it to finance operational expenses like supplies, payroll and inventory. You can also use it to pay rent or even tax obligations as you wait for clients to pay you or as you work to increase revenue.

An unsecured business line of credit offers business owners great freedom. Not only does it allow them to cover their financial obligations even when cash flow is tight, but it also allows business owners to use the funds in whatever way they choose. An unsecured line of credit does not have to be designated for a specific purpose; a business owner is free to use it for whatever business needs they have.

As businesses work to recover from the effects of the coronavirus pandemic and social distancing requirements, maintaining cash flow remains a daunting challenge for many. A small business line of credit can be the answer to obtaining the cash you need, when you need it, to keep your business moving forward.

The views expressed by the author are not necessarily those of Fifth Third Bank, National Association, and are solely the opinions of the author. This article is for informational purposes only. It does not constitute the rendering of legal, accounting, or other professional services by Fifth Third Bank, National Association or any of their subsidiaries or affiliates, and are provided without any warranty whatsoever. Deposit and credit products provided by Fifth Third Bank, Member FDIC.