A business line of credit is what’s called revolving credit, meaning you can use it over and over rather than just once (like you would with a term loan). Here’s how that works:
First, you have to get approved for your business line of credit. When you get approved, you’ll get a certain credit limit―or the amount of money you can borrow. Your business’s credit limit will depend on things like your lender and your borrower qualifications (such as credit score and revenue).
Then you can borrow against your credit limit. Now, you don’t have to borrow your maximum amount. If you have a $50,000 credit limit, for example, you can draw $10,000 one day and another $5,000 a few days later. (These transactions are often called draws from your credit line.) Or, yes, you can borrow the whole $50,000 at once.
Either way, whatever amount you borrow becomes its own term loan, with its own interest rate, fees, and repayment term. So if you do multiple draws, you basically have multiple term loans.
But unlike normal term loans, once you pay those draws back, the money becomes available again. So if you borrow $10,000 from your $50,000 credit line, you’ll have another $40,000 you can borrow. But once you’ve repaid that $10,000, you’re back up to $50,000. And there’s no need to get re-approved to borrow more. (Some credit lines do expire, so you’ll need to eventually get re-approved.)
So how does a business line of credit compare to a normal term loan?
Well, like we already mentioned, a normal business loan is a one-time thing. You get and use your funds, and then you have to re-apply for another loan if you need more money.
A credit line, on the other hand, lets you borrow over and over again without going through a pesky loan application process.
With that in mind, a revolving line of credit can work for pretty much any business expenses that come up, from payroll needs to inventory purchases to business improvements and even some equipment purchases. But generally, you’ll have a specific business need in mind when you apply for a term loan.
You might also think a business credit line sounds pretty similar to your credit card―and you’re not wrong. They’re both types of revolving credit.
The big differences? Well, a business credit card usually has a much lower credit limit than a business line of credit. Likewise, business credit cards generally have higher interest rates than credit lines do.
That means that business credit cards work better for small day-to-day expenses, like team lunches, office supply runs, and so on. Business credit lines work better for larger cash flow needs, like bigger purchases, hiring, and business improvements.
(For more details, we’ve got a breakdown of lines of credit vs. credit cards.)