Differences Between Personal and Business Lines of Credit
A line of credit, whether business or personal, is a flexible borrowing agreement with a lender that you can draw from and pay back as needed. There is a cap, but not a minimum, to the amount you are able to borrow, and you pay interest only on the portion you’ve taken out. It operates similarly to a credit card, though interest rates tend to be far lower.
Lines of credit can be secured or unsecured. With unsecured funding, getting approved depends on how creditworthy the lender interprets you or your business to be. These types of credit may have more stringent qualification standards, and possibly higher interest rates.
Collateral is different for a business line of credit than a business loan from a bank. While a business loan may require a large asset such as property, business lines of credit are typically secured with short-term assets such as accounts receivables. Personal lines of credit, however, are typically secured with assets such as a car or home.
Revolving credit is meant to smooth out cash flow, not finance large purchases. Business lines of credit are typically used to cover unexpected expenses that exceed a firm’s normal cash flow. They also allow owners to take advantage of growth opportunities – a large order beyond normal capacity, for example. Note that for large purchases you expect to pay over time, such as real estate or equipment, term loans will generally be a far cheaper option.
There are no restrictions to how you use a personal line of credit, except the amount you can borrow. Beware that if your business is registered as a corporation, you could invalidate your status by paying for business expenses using a personal line of credit. Commercial credit lines, on the other hand, can only be used for business uses such as payroll or inventory.
Business lines of credit are one of the easier borrowing options for entrepreneurs without stellar credit. However, lenders would still prefer to see an established business with sound financial history, business bank accounts in good standing, and great personal or business credit scores. Companies with less than two years of operating history will likely be rejected, or may only qualify for smaller amounts until a credit history is established. Personal, corporate, or U.S. Small Business Association guarantees may also improve eligibility.
Banks want to know how they will get their money back. For a business line of credit, it’s assumed that repayment will come from the firm’s operations. Owners will need to provide documentation that may include financial statements, tax returns, firm assets, and even personal resume. They may also be required to explain how the loan will be used, as well as projections of future profits.
With personal lines of credit, the lender will review personal assets, income, and credit history. Many of the materials needed are easily obtainable, such as pay stubs, W2s, proof of address, and personal identification documents. The application process is therefore much simpler, and can often be done entirely online.
Personal and business lines of credit each come with benefits and hurdles. For instance, business revolving credit might be a cheaper financing source, but your firm may lack sufficient operating history to qualify. The better option will depend on your company’s situation. You should also make sure to weigh this type of funding against other sources available, such as personal or business term loans.
Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author's alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.