Line of Credit
A line of credit (LOC) is a flexible loan that gives you access to a set amount of money that you can draw from as needed. Unlike a traditional loan where you receive a lump sum, a line of credit lets you borrow only what you need, repay it, and borrow again — similar to a credit card but typically
Line of Credit Definition
A line of credit (LOC) is a flexible loan that gives you access to a set amount of money that you can draw from as needed. Unlike a traditional loan where you receive a lump sum, a line of credit lets you borrow only what you need, repay it, and borrow again — similar to a credit card but typically with lower interest rates. You only pay interest on the amount you've actually drawn, not the full credit limit.
Line of Credit in Practice — Example
A seasonal landscaping business secures a $75,000 business line of credit. During the slow winter months, they draw $30,000 to cover payroll and equipment maintenance. When spring arrives and revenue picks up, they repay the $30,000 over three months. In summer, a large commercial contract requires upfront material purchases — they draw $50,000 and repay it as client payments come in. The LOC acts as a financial safety net that flexes with the business cycle.
Why Line of Credit Matters for Your Business
Cash flow isn't always predictable. Seasonal fluctuations, slow-paying clients, unexpected expenses, and growth opportunities all create timing gaps between when you need money and when it comes in. A line of credit gives you instant access to capital without the delay and paperwork of applying for a new loan each time.
Having an established line of credit also puts you in a stronger position for opportunities. When a bulk discount, equipment deal, or acquisition comes up, you can move quickly instead of scrambling for financing. The best time to set up a line of credit is when you don't need it — lenders are more favorable when you're financially healthy, and the credit is there when the unexpected hits.
How a Line of Credit Works
Key terms:
| Term | Meaning |
|---|---|
| Credit Limit | Maximum amount available to borrow |
| Draw | Taking money from the line |
| Repayment | Paying back what you've drawn |
| Revolving | Can draw and repay repeatedly |
| Interest Rate | Charged only on the outstanding balance |
| Draw Period | Time frame during which you can borrow |
Types of lines of credit:
| Type | Best For | Typical Rate |
|---|---|---|
| Secured LOC | Lower rates, larger limits | Prime + 1-3% |
| Unsecured LOC | No collateral required, faster setup | Prime + 3-10% |
| SBA Line of Credit | Small businesses, favorable terms | Variable, ~Prime + 2-5% |
Cost example:
Line of Credit vs Term Loan
A line of credit is revolving — draw, repay, repeat — and you only pay interest on what you use. A term loan gives you a lump sum upfront that you repay in fixed installments over a set period. Use a LOC for ongoing working capital needs and cash flow management. Use a term loan for one-time purchases like equipment or real estate.
FAQ
Q: Does a line of credit affect my credit score? A: Opening one may cause a small, temporary dip from the hard inquiry. But having available credit you don't fully use actually improves your credit utilization ratio, which can help your score over time.
Q: What collateral do I need for a business line of credit? A: Secured lines require collateral (real estate, equipment, inventory, or receivables). Unsecured lines don't require specific collateral but usually need strong credit, business history, and may include a personal guarantee.
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