A business line of credit can be a helpful alternative to a business term loan. These revolving funding sources let you borrow up to a preset limit, repay the lender and then borrow that money again. But if you don’t know how to use a credit line wisely, you might not get the maximum benefit to your business. You could even hurt your finances.

Use these seven tips to manage your business line of credit well.

Key takeaways

• Since a business line of credit is reusable, it can cover cash flow gaps as needed

• Calculate the loan cost plus interest and fees with each withdrawal

• On-time payments build your ongoing relationship with your lender

• If you’re in good standing, you could ask to increase your line of credit

1. Be strategic about withdrawals

A business line of credit differs from a term loan because you don’t get a lump sum of cash. Instead, you have a revolving line of credit to use when needed. It works much like a credit card: You must pay interest on borrowed funds. As you repay the balance, that amount is available to borrow again. 

Businesses can use a line of credit to bolster cash flow during slow times. For example, if your business is seasonal, you could use your LOC to pay for operating costs like inventory while being cash-poor from outstanding invoices. Lines of credit can also act as a short-term loan, helping you pay for small expenses that you know you can pay off quickly.

However, you shouldn’t use your line of credit when you don’t need to. It might be better to look for efficiencies and cut back on spending — eliminating or reducing your need to borrow — rather than taking on debt that you’ll need to repay with interest.

2. Account for fees

While you usually don’t have to pay interest on a business line of credit until you spend money, you may have to pay some fees. Understand what fees you will pay and why so that you can budget accordingly. 

Common line of credit fees may include:

• Origination fee: A one-time fee charged when you open the business line of credit

• Maintenance fee: Monthly or annual fees for holding an account

• Inactivity fee: Fees that may be charged when you don’t draw funds from the account often enough

• Draw fee: A fee charged when you spend money from the account

• Renewal fee: A fee charged if you renew the LOC for an additional draw period

3. Understand the interest rate

Typically, you start accruing interest on a LOC when you draw funds. To help you manage payments, know your interest rate and how much you’ll pay in interest when you decide to draw funds.

Let’s say you use $10,000 from your business line of credit and it has an interest rate of 10 percent. If you want to pay off the balance in one year, you’ll need to make a monthly payment around $880. In total, you’ll pay about $550 in interest.

You can use a business loan calculator to figure out costs based on your repayment schedule. Here’s a breakdown of the total borrowing costs for this example, assuming a 12-month repayment term:

• $879.16 x 12 months = $10,549.92

• $10,549.92 (total loan cost) – $10,000 (original loan amount) = $549.92

4. Make on-time payments

To avoid late payment fees or even defaulting on a business loan, making your payments on time is vital to any business loan. On-time payments also build your business credit score, helping you secure financing in the future with favorable interest rates and repayment terms.

If you want to save money on interest, you can also make extra payments to pay down the balance more quickly. As you pay down the balance, interest gets calculated on the new lower principal amount. This leads to paying less in interest over time, though your regular payments will stay the same.

But paying quickly also means making higher payments. If your business is short on cash, that might not be possible. In this case, a better strategy for managing your credit line might be to make smaller payments and swallow the extra interest costs instead of emptying your pockets. Use your knowledge of your business’s cash flow patterns to set your strategy.

5. Ask to increase your business line of credit (if it makes sense)

Having a line of credit for your business can help increase your business credit score if you make timely payments and manage your payments well. Another way to potentially increase your credit score is to ask for a credit line increase after the account has been open for at least a few months. If your limit grows but you keep the same spending habits, your credit utilization ratio will decrease — and a lower ratio may mean a higher score.

However, asking for a credit line increase is not always a good idea. It doesn’t make sense to increase your line of credit if you recently made any late payments on your account. The lender will be unlikely to say yes.

6. Why managing your business line of credit is important

A business LOC can be a great tool for businesses, but it matters that you manage your credit well. Here’s why:

• Can boost your business credit if the lender reports your timely payments to business credit bureaus. On the other hand, if you miss payments, you could damage your credit score.

• Helps build a case for getting a credit limit raise from your lender

• Overspending and mismanagement can put you in debt that gets worse as interest accumulates and could even lead to bankruptcy.

• Allows you to keep the LOC open to use as a helpful tool for your business

7. When not to use your business line of credit

If you’re continually losing money on operating costs, using your line of credit may not be the best option. Ongoing losses signal that you have a bigger problem than a business loan can fix. If you have a leaking ship, it’s better to patch the leak than keep bailing water.

You can start by taking a hard look at your business budget and seeing where you can adjust expenses. If you have an existing business loan or you’ve already drawn from your credit line, you could think about refinancing to a new loan. If you have multiple business loans, you’d look for a loan that you could use to consolidate your debts into one loan, preferably with lower interest rates.

To refinance or consolidate, you could either talk with your current lender or compare small business loans to find a lower interest rate than your current loan or longer repayment term. Keep in mind that a longer repayment term won’t save on interest, but it will lower your monthly payments to make them manageable.

The bottom line

Using a business line of credit can support strong finances for your company, but it can also hurt them. Before withdrawing money, make a plan to manage the credit line and understand how the payments and fees will fit into your current budget.

Frequently asked questions

• Do business lines of credit require collateral?

  Secured business lines of credit require you to back the loan with business collateral, while unsecured lines of credit don’t. A lender may require you to sign a personal guarantee with either a secured or unsecured line of credit. This essentially guarantees the loan with personal assets.

• Is there a cost to using a line of credit?

  Yes, lines of credit have borrowing costs like any other business loan, including interest payments. Some lines of credit have a one-time origination fee when opening the credit line. Some also charge a draw fee each time you withdraw funds, usually a percentage of the loan amount.

• What is a disadvantage of using a line of credit?

  A business line of credit could cause financial strain if you draw more money than you need. Or you could get into a cycle of debt if you withdraw multiple times and have to manage more than one loan. As reusable credit, lines of credit are similar to business credit cards, except that they don’t have a grace period that lets you avoid interest if you pay off the balance in full.