What is a Business Line of Credit and How Does It Work?
There are 158,844 small businesses in New Mexico that make up 99% of total businesses in our state. If you are a small business owner in Northern New Mexico, you know all about the ups and downs of running a business, including dealing with seasonal or one-time cash flow shortages. Do you need short-term funding to cover operational expenses during the slow season or while you’re waiting for client payments to come in? As a local credit union, we are committed to meeting the needs of the small businesses that power our state economy. Keep reading to learn all about what a business line of credit is, what it can be used for, how it is used, and how to get a business line of credit.
What is a Business Line of Credit?
A business line of credit is a flexible type of business loan, similar to a business credit card. Business lines of credit usually have a variable interest rate. This type of financing can be tapped when you need it and used as many times as you want up to the maximum borrowing limit, which usually ranges from about $5,000-$100,000. There is an option to make interest-only payments while the business line of credit is active. Unlike a business credit card, a business credit line acts like cash–you can transfer funds between the credit line and your business checking account.
How Does a Business Line of Credit Work?
Unlike a business equipment or real estate loan, a business line of credit is not designed for a specific use. Most business owners use a credit line for short-term financing or off-season working capital. Operational expenses are the most common use of a business line of credit. For example, you may need funding to purchase supplies, make payroll, or purchase inventory. Even if you don’t need short-term financing right now, you may want to open a business line of credit to be prepared for future cash flow gaps to support short-term working capital needs.
Business Line of Credit vs. Business Term Loan
Not sure which type of business financing is best for you? Let’s compare the features of a commercial line of credit with New Mexico small business loans.
Availability of Funds
With a business term loan, you receive a lump sum for the amount borrowed after the loan is approved. On the other hand, business lines of credit offer more flexibility: you can open one without using the funds right away.
Business term loans usually have a fixed interest rate, whereas business line of credit rates are variable, meaning they can change over time. Depending on the terms of your credit line and the benchmark rate it’s tied to, the interest rate could adjust up or down. Recently, we’ve been in a rising interest rate environment. However, that also means interest rates on savings accounts will increase. You can hedge against rising rates on your credit line by also keeping some money in a business share certificate. Of course, if you don’t use the credit line immediately or pay off what you borrowed, you won’t incur much or any interest.
Business term loans are repaid in fixed monthly installments. With a commercial line of credit, you can make interest-only payments or pay more than that. Again, there is more flexibility with a credit line.
Business term loans are best for a large, pre-determined expense. Lines of credit are best for multiple smaller expenses, such as short-term operating costs, or for dealing with the unpredictable.
Building a Credit History With Your Business Line of Credit
Just as it’s important to build a good personal credit history, your business will also benefit from establishing a solid credit history. If you have never borrowed money before for your small business, maintaining a commercial line of credit in good standing is a great way to start. You will build a business banking relationship and be better positioned for future small business financing.
What is a business credit score?
While there is more than one business credit score model, one of the most commonly used is the Paydex Score from Dun & Bradstreet. This score model measures your business’s past payment performance on a scale of 1-100. You want to aim for at least a score of 80, which indicates a low risk to commercial lenders. To check your Paydex score, you need to sign up for a D-U-N-S Number for your business to create a D&B file on your business. First, look to see if Dun & Bradstreet has already created a D-U-N-S number for you.
If your small business does not yet have a credit score, your personal credit score and history would be used in processing your business credit line application. That’s why it’s important to manage your personal finances well enough to maintain a good credit score. You should also separate your business and personal finances with different bank accounts, credit cards, etc.
What are the Requirements to Get a Business LOC?
Applying for a commercial line of credit is similar to the process of applying for other business loans. At Del Norte Credit Union, our business bankers can help guide you through the process. Generally, you’ll need to provide:
- Length of time in operation
- Personal and business identification information
- Personal and business tax returns
- Bank account statements and financial/accounting statements of business operations
- List of outstanding debts and loans
Depending on your business’s financial situation, credit history, and length of time in business, you may also need to provide collateral or sign a personal guarantee.
Learn more about business lines of credit with Del Norte Credit Union!
Del Norte Credit Union (DNCU) is a member-owned, not-for-profit financial institution in Northern New Mexico committed to providing unparalleled, sound, and unbiased financial advice. Our knowledgeable employees can help you find the right business loan option to meet your financial needs and achieve your goals for growth. Learn more about our business lines of credit and apply for a business line of credit online today! You can also call us at 877-818-DNCU to speak with a Service Advisor.
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