A small-business line of credit can come in handy when unexpected expenses pop up or revenue is slow to arrive.

When you have one, you’re authorized to borrow up to a specific amount, drawing funds as you wish. You’ll pay interest only on the money you borrow.

Small Business PartnersHere’s everything else you’ll need to know about opening one for your small business.

Credit lines vs. other financing options

Small businesses usually obtain financing in one of three ways: a loan, a line of credit, or a business credit card.

When you receive a loan, you borrow one lump sum and make fixed payments. Business credit cards, on the other hand, have a similar borrowing and payment arrangement to credit lines. The big difference between the two is that credit cards tend to have higher interest rates.

A loan is a smart way to finance a long-term investment in your business. A business line of credit is a better option for funding unexpected expenses ― say, fixing broken equipment ― buying inventory to fill rush orders, managing your cash flow and other short-term, occasional needs.

What to expect from lenders

Because lines of credit are often unsecured, a lender might be reluctant to grant you one — or more likely to impose unfavorable terms — if your business is struggling. That’s why the best time to establish one is when you’re generating a positive cash flow and your business is in overall good health.

If you don’t already have one, start a business bank account, pay all your bills on time, and take other steps to establish your business’s creditworthiness. You might apply for a low-limit line of credit first. Keep it in good standing by making on-time payments, and you might be granted a limit increase later.

Lenders might also grant you a credit line, but require collateral. This might be the case if you’ve been in business for less than two years or can’t show consistent revenue.

Lenders to consider

Banks, credit unions and online lenders can all help small businesses with financing, and small, local institutions might be your best bet. A recent Federal Reserve Bank study found that small banks meet some of the financing needs of 76% of applicants, while online firms meet the needs of 71% of applicants, and larger banks meet the needs of 58%.

A business line of credit can be a useful tool for dealing with short-term issues. It’s also a good way to build your business’s credit score.

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