An unsecured line of credit is among the most attractive external financing options. Find out how to determine if it’s the right one for you.
Does your business have any cash flow issues? Are there any pressing matters that require more money than you have on hand? If so, an unsecured business line of credit can be a fitting solution. Unsecured lines of credit are a type of small business loans and can be an alternative way to get a business loan. When considering external financing options, business loans—including both secured and unsecured types—are commonly used by businesses to meet various funding needs. Unlike term loans, it’s a highly flexible and cost-effective way of injecting some cash into your business when you need it. This option can also provide funds upfront for urgent business needs, offering immediate access to capital.
Of course, this doesn’t mean it’s perfect for everyone. There are a few things that you need to consider before you decide to apply.
1. Can You Afford It?
As there’s no collateral, your lender will have to assume a higher risk. Because of this, you’ll want to make sure that you can meet the interest rate charges and additional fees. This requires you to take a close look at your cash flow and see how much you’re able to set aside for repayments.
One of the biggest advantages of an unsecured line of credit is that you only have to pay the interest and fees on a monthly basis. Better yet, the interest only applies to the amount of money drawn.
This means that there are no deadlines to paying it back. You can pay down the credit line as much as you can afford, and then draw down more of that line of credit as needed.
Despite this convenience, you still need to make sure you can pay the price of your unsecured line of credit. The interest rate can vary based on different factors, and there are a few one-off and ongoing fees that you have to account for. Several factors, such as your individual circumstances and the interest rate type—whether fixed or variable—will influence the cost and terms of your line of credit. You may be offered a variable rate, which can change over time and affect your repayments, or fixed rates, which provide predictable payments for a set period. Fixed rates offer stability and certainty, while a variable rate can offer more flexibility but comes with the risk of fluctuating repayments.
2. Why Do You Need It?
In general, business owners turn to an unsecured line of credit to meet their short-term capital needs. An unsecured line of credit is a popular form of short term funding, providing quick access to capital without the need for collateral. You shouldn’t draw money out of your credit line to spend on unnecessary projects that won’t help your business grow.
One of the most common reasons why businesses need an unsecured LOC is seasonal business performance. For example, the summer may be the slow season for certain business, but in spite of the slower receipts, you can use a line of credit to ensure smooth day-to-day operation. And once the business picks back up, you can pay down the credit line and save it for the next off season.
In addition, an unsecured business line of credit is perfect when lucrative opportunities come up unexpectedly, such as if a supplier offers a sizable discount for you to stock up. This is also true for projects you can’t afford. For example, you might want to launch a marketing campaign that isn’t going to bear fruit now but the future. A line of credit can also be used to fund expansion or invest in growth initiatives, such as purchasing an existing business or expanding your operations.
You can take the money out of your credit line and finance the campaign, then pay it down once you see the results. Not only that, but you might also generate additional profits on top of that.
After that, you can leave the LOC sitting there until you need it again. Better yet, this doesn’t create any expenses. Evaluating your business needs and goals will help you choose the right loan for your specific situation.
3. How Much Can You Borrow?
It doesn’t make sense to take out a line of credit that doesn’t cover all your needs. This may even result in your business having to pay interest and fees for no reason. This is why you need to find a lender that will give you all the money you need at reasonable terms.
This depends on both the lender and your own standing. Lenders generally have a fixed minimum and maximum amount they’re willing to offer their clients. The approved limit is the maximum loan amount you can access, and this is determined by the loan type you choose and your business history.
More importantly, your credit history will ultimately determine how much you can borrow as well as the borrowing costs. Many third party lenders are willing to take another look at those who couldn’t get approved by major banks. Still, those with a good credit history can get a better deal, as they can show that they’re a more reliable borrower. Lenders may also offer different loan term options based on your business history and overall financial profile.
It’s best to find different options and compare them to see what works best for you. In addition, you might want to find a way to improve your credit profile in order to negotiate a better deal. The main difference between various loan types, such as secured and unsecured loans, is whether collateral is required and the borrowing limits that apply.
4. How Long Will It Take Until You Get the Funds?
The exact approval period will depend on factors specific to your needs and performance. But in general, it takes much less time to get an unsecured line of credit approved compared to any secured loan products.
By virtue of putting up an asset as collateral or security, the lender would have to evaluate the asset to their best ability. Your application might go through many officers and loan managers. As a result, it can take weeks or even months for your application to get approved. Most lenders require collateral and a detailed business plan as part of the application process for secured loans, which can further extend the timeline.
In comparison, the application and approval process for an unsecured LOC is much simpler. The application process is generally faster because you do not need to provide collateral, allowing you to potentially get an approval in as little time as a few hours.
Of course, this will vary from one lender to another, and from one borrower to another. Before you apply, do your part and establish that you’re deserving of the lender’s trust.
What Are the Risks?
When you’re considering a business loan, it’s vital to weigh the potential risks before making any commitments. One of the biggest risks is the possibility of defaulting on your repayments, which can negatively impact your credit history and put your business’s financial situation in jeopardy. If you opt for a loan with a variable interest rate, keep in mind that interest rates can rise unexpectedly, increasing your repayment amounts and straining your cash flow.
Secured loans come with their own set of risks, as you’ll be required to put up an asset—such as property or equipment—as collateral. If your business is unable to repay the loan, you could lose that asset, which may be critical to your operations. To protect your business, always review the loan terms carefully, assess your finances with a detailed cash flow statement, and ensure your business plan is robust and realistic. By understanding these risks and planning accordingly, you can make smarter borrowing decisions and safeguard your business’s future.
Common Mistakes to Avoid
Applying for a business loan can be a complex process, and there are several common pitfalls to watch out for. One frequent mistake is not fully understanding the loan terms, including the interest rate, fees, and repayment schedule. Overlooking these details can lead to unexpected costs and financial strain down the line. Another error is borrowing more than your business actually needs, which can result in higher repayments and unnecessary debt.
It’s also important not to overlook alternative finance options. Unsecured loans or lines of credit might be better suited to your business needs, especially if you don’t want to put up collateral or need more flexibility. Take the time to research and compare different loan options, considering both secured and unsecured finance solutions. By being thorough and asking the right questions, you can avoid costly mistakes and choose the right business loan for your situation.
Are There Better Alternatives?
Before settling on a traditional business loan, it’s worth exploring whether other finance options might better suit your business needs and financial situation. For example, invoice finance can help you manage cash flow by unlocking funds tied up in outstanding invoices, while equipment finance allows you to purchase or upgrade assets without a large upfront payment. If you’re looking for stability, a fixed interest rate or a secured loan might offer more predictable repayments and lower risk.
Non-traditional lenders and fintech companies are also changing the landscape, providing innovative finance options that can be more flexible and competitive than those offered by traditional banks. By carefully assessing your business goals, financial position, and the specific needs of your business, you can determine if these alternatives are a better fit and potentially save money or gain more flexibility in the long run.
How Will You Manage and Repay the Loan?
Successfully managing and repaying your business loan starts with solid planning and ongoing financial discipline. Begin by preparing a comprehensive cash flow statement and regularly reviewing your financial statements to track your business’s financial health. Setting up a dedicated account for loan repayments can help you stay organized and ensure you never miss a payment.
If your loan allows, consider making extra repayments or taking advantage of flexible repayment options to reduce your loan term and save money on interest. Prioritizing your loan repayments and maintaining a healthy cash flow will not only help you meet your obligations but also strengthen your business’s financial position for future growth.
Business Loan Checklist
Before you apply for a business loan, it’s important to be fully prepared. Use this checklist to ensure you’re ready to move forward:
- Review your credit history and financial statements to confirm your eligibility for a loan.
- Clearly define the loan purpose and determine the exact amount you need to borrow.
- Assess your cash flow and your ability to repay the loan without straining your business finances.
- Explore different loan options, including secured and unsecured loans, fixed and variable interest rates, and alternative finance solutions.
- Carefully evaluate all fees and charges associated with each loan.
- Develop a detailed business plan and cash flow statement to support your business loan application.
- Seek independent tax advice to make sure you’re making the best financial decision for your business.
- Compare offers from multiple lenders to find the most suitable loan for your business needs.
By following this checklist, you’ll be well-equipped to apply for a business loan, avoid common pitfalls, and make informed decisions that support your business goals and long-term financial health.
Is an Unsecured Business Line of Credit Right for You?
After answering the above questions, you’ll know if an unsecured line of credit is a good option for your capital needs. As convenient and flexible as it is, not everyone may find it worthwhile. This has to do with the higher interest rates since you don’t have to put up any collateral. Unsecured business loans and unsecured loans generally come with a higher interest rate compared to secured options, especially for those with bad credit.
Unlike secured loans, unsecured business loans do not require you to secure the loan with business assets or physical assets as collateral, making them easier to access for a new business or those without significant assets. This can be especially helpful if you need business finance quickly to support business viability or growth.
On the other hand, you’re not risking any of your valuable assets and you can have the money you need right away. As long as you can meet the interest rate repayments, this can be a great option for getting the cash you need. Regular repayments are required over an agreed period, and the loan is repaid in full by the end of the fixed period. Choosing between variable rates and fixed rates can help manage your cash flow, depending on your business finance needs and business viability.
Still not sure if you should go with an unsecured line of credit or want to know more about the difference between a line of credit and a business loan? We’ve got you covered. To learn more about applying for an unsecured business line of credit, go ahead and visit our site, or read our detailed guide on the difference between a line of credit and a business loan.
