A business line of credit (LOC) is an often overlooked option for small business owners in search of capital. Business loans and business credit cards have greater buzz. But a business line of credit can be a valuable tool to even out cash flow dips, especially for businesses working through seasonal operations, slow paying clients, or unexpected disasters. On the positive side, a business line of credit can also be a good choice to finance a special project – like a major new marketing campaign – or buy upgraded equipment.
Unfortunately, bad credit presents a challenge to many owners who’d like to open a business LOC. Banks and lenders who provide LOCs need to see a certain level of credit-worthiness before they’ll let you open a business line. Businesses without a long operating history or a recent history of negative cash flow probably won’t be eligible. And of course, the personal credit score of the business owner, as well as the business’s credit score matter. A bad credit score isn’t going to cut it. You don’t necessarily need excellent credit, but bad credit is a non-starter.
If you have bad or poor credit, there are steps you can take to start improving your credit score. Business lines of credit are flexible resources that can help support a business. It’s smart business to put yourself and your business in the best place possible to set one up.
UNDERSTANDING BUSINESS LINES OF CREDIT
Before I jump into how to start repairing your bad credit so you can get a business line of credit, I’m going to dig a bit deeper into exactly what a business LOC is. They’re often confused with business loans and business credit cards. At least, most people don’t understand how a business LOC differs from these other financing sources.
When you open a business line of credit with a bank or lender, you gain access to cash when you need it, up to a certain amount. You might access the cash via a card issued by your LOC source, or by check. In many cases, you can also transfer LOC cash available via ACH. If you have a revolving business line of credit, you can increase the amount of credit you have available as you start paying it back.
So let’s say you have a $10,000 revolving business line of credit and use $3000 of it to pay suppliers while you wait for a client to pay an open invoice. Now you have $7000 left available on your business line of credit. Once your client pays, you use that money to make a payment on your LOC. That re-ups the total amount of credit available to you on your LOC to $10,000. If your business LOC was non-revolving, then you’d still have only $7000 left on your LOC even after you pay back the first $3000 tapped.
Your business LOC can also be secured or unsecured. The terms on a secured business line of credit will probably be a bit better than unsecured, but that’s because you’re risking an asset in case you can’t pay back the LOC. The most common ways to secure a business line of credit are with accounts receivable or inventory.
So why wouldn’t you just look into a business loan or business credit card, instead of a business LOC?
Great question. I’ll start with the differences between an LOC and business loan.
Business lines of credit provide a lot more flexibility than a business loan. For starters, you don’t have to specify – and justify – what you want to use the money for, which you do for a business loan. Also, the interest rate on a business loan is usually a fixed rate. The interest rate on an LOC is variable, typically tied to the market’s variable rate. The LOC interest rate will also probably be a bit higher than the interest rate charged on a business loan.
This isn’t all bad news. On a business loan, you start paying interest on the entire amount from day one. Not so with a business line of credit. You’ll only pay interest on amounts actually used. You also aren’t stuck in a fixed monthly payment like you’ll have with a business loan. Your minimum monthly payment required for a business line of credit depends on how much you’ve drawn off your line of credit. What you don’t pay, you’ll pay interest on.
In its best, most flexible light, the business line of credit gives you a degree of comfort, stability, and control that you don’t have with a business loan. Having a business line of credit on hand to access when needed is an easier, less stressful option than re-applying for business loans.
I know what you’re saying – but credit cards are pretty flexible. You’re right. A business line of credit can be more useful and make more financial sense than a business credit card because you can typically get a higher limit on an LOC, say $20,000. Second, while the interest rate on an LOC is higher than on a business loan, it’s much lower than what you’ll pay on outstanding credit card balances.
That doesn’t mean a business credit card doesn’t have its place. In fact, it’s one tool you can use to start improving your business credit score.
STEPS TO TAKE TO IMPROVE YOUR BAD CREDIT SCORE
A business line of credit lender will look at both your personal and business credit scores. As discussed, an LOC is access to capital on flexible terms. So lenders want certain expectation of credit worthiness. I’ll go over some steps here to help you improve your credit, but keep in mind there are no quick fixes. It does take some time.
- Make sure your business-related accounts are listed under your business name, and not personal accounts. This means bank accounts, and more importantly, all the bills you pay. Put your business’s utilities, Internet, cell phones, electricity in your business’s name. They’ll start building your business credit.
- Get a business credit card. I explained above how a business line of credit has benefits over a business credit card. But if you need to fix bad credit in order to get that LOC, a business credit card is part of that fix. Don’t use the credit card to cover whatever it is you want the LOC for. Instead, use if for normal business expenses in an amount you can pay off, on time, each month. Use the business credit card responsibly to start showing reliable payment history.
- Look at your credit reports, personal and business to make sure they’re accurate. If you see outstanding balances or reports of late payments that aren’t accurate, get together documentation that proves otherwise. Then you can try to get any inaccuracies dragging down your credit score removed from your report.
- Understand the difference between historical and current late payments and delinquencies. There’s nothing you can do about historical late payments. You can make current delinquencies on bills, mortgage, or loans a bit less harmful. Time matters. A 90-day delinquency is a critical marker that moves a delinquency into a major black mark on your credit score. If you have delinquencies, do what you can to bring all them under the 60-day mark. You don’t need to make them current, but you can cut down on the number of days an overdue account is considered late. Say you have a business loan that’s 87 days late and you make a couple of payments on it. You’re not making it current, but from a credit reporting point of view, that account is now 27 days late. Much different.
- Don’t let anything go into collection. If you have severe delinquencies, see if you can negotiate a settlement. If you already have an account in collection, you can still try to negotiate a settlement, but collection agencies can’t let you “pay” to have the collection removed from your credit report. They do have to report payments and if the collection account is closed. It’s a fine distinction.
- This one is a bit counter-intuitive. Don’t take action on old, outstanding accounts. Bad accounts and payment histories do eventually age-off your credit report. As they get older, they’re impact on your credit score reduces, even if they’re still on your report. If you make payment on any of them, that reactivates the account and makes it current again. So when it comes to working tip #4, focus on delinquent accounts no more than five years old.
- Pay off what you can, the more recent the account, the better. It’s a challenge to balance the prioritizations of which delinquencies to address first. If you have a recent outstanding debt or delinquency you can make current, do it. If that means you make a lower payment on a slightly older delinquency, it may be worth it as cleaning up the most recent delinquencies can have the most impact on your credit score.
These are some tips. There’s no magic formula, and no one can ever predict exactly how fast or by how much a credit score will improve. It took you time to depress your bad credit score, it will take time to revive it.
With planning, patience, and discipline, you can revive your credit score. Then you’ll have access to the financial flexibility and stability that a business line of credit offers your business.