Business credit lines are a type of revolving account. Business credit lines are an arrangement between a financial institution, usually a bank, and a customer that establishes a maximum loan balance that the lender permits the borrower to access or maintain.
The borrower can access funds from the line of credit at any time, as long as he does not exceed the maximum amount set in the agreement and as long as he meets any other requirements set by the financial institution, such as making timely minimum payments.
The main advantage of business credit lines are its built-in flexibility. Borrowers can request a certain amount, but they do not have to use it all. Rather, borrowers can tailor what they spend to their needs, and they only have to pay interest on the amount they spend, not on the entire credit line. In addition, consumers can also adjust their repayment amounts as needed, based on their budget or cash flow. For example, borrowers can repay the entire outstanding balance at once, or they can opt to just make the minimum monthly payments.
Revolving accounts such as lines of credit and credit cards exist in contrast to installment loans such as mortgages, car loans and signature loans. With installment loans, consumers borrow a set amount of money, and they repay it in equal monthly installments until the loan is paid off. Once an installment loan has been paid off, the consumer cannot spend the funds again unless he applies for a new loan.
In most cases, business lines of credit are unsecured loans. This means that there is no collateral backing them. However, there is one notable exception, which is a home equity lines of credit (HELOC). This line of credit is secured by the equity in the borrower’s home, but it works exactly like any other line of credit.
A demand LOC is a rare type of credit line in which the lender can call the loan due at any time. As with a standard LOC, the lender sets a maximum amount the borrower can spend, and the borrower can spend any amount up to the limit. With demand loans, the borrower may make small monthly payments, or he or she may simply wait until the lender demands repayment.
Standard loans and business credit lines represent two different methods of borrowing money for both businesses and individuals. Typical loans might include mortgages, student loans, auto loans or personal loans; these are one-time, lump-sum extensions of credit that tend to be paid down through periodic, consistent installments. Standard loans are more likely to be secured against an asset. Lines of credit tend to have higher rates of interest and smaller minimum payment amounts. Lines of credit usually create more immediate, larger impacts on consumer credit reports and credit scores. Closing costs, if any, are higher for loans than lines of credit on average.
Two major differences between these two borrowing methods involve the “when” and the “what for.” If you are approved for a loan, you receive the full loan amount right away and usually begin accruing interest on those funds immediately. If you are approved for a line of credit, you receive the ability to borrow up to a certain amount right away, but you are not going to receive a large check or money transfer up front. Interest accumulation only begins once you actually make a purchase against the credit line. Many loans also require a specific purpose; for instance, you take out a student loan to pay for higher education, you are granted a mortgage to buy a property, etc. Lines of credit, however, do not typically have a specific purchase purpose. Purchases can be made on a variety of items without the lender’s approval, and no assets have to be appraised.
In this way, business credit lines represent a much more flexible borrowing tool. Payments also tend to be much more flexible for business credit lines, since the amounts and dates of purchase are uncertain. This uncertainty is offset by higher rates of interest and, sometimes, higher lending standards; it is very difficult to obtain an unsecured line of credit for any substantial amount.
Business credit lines act very similarly to credit cards, though they are not identical. Unlike credit cards, lines of credit can be secured with real assets such as a home. While credit cards always have minimum monthly payments based on a percentage of current credit balances, lines of credit do not necessarily include monthly payment requirements. Some individuals even take out personal installment loans to pay off lines of credit as a way to build their credit scores. In this way, the two forms of debt can be used to complement each other.
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