Business credit and lines

In short

If you are running a small business, you have probably wondered how to borrow money without putting your home on the line. Business credit is a record of how your company pays its bills, and it can be built apart from your own personal score. A line of credit is a pool of money a lender sets aside, and the owner draws from it only when needed. Interest is charged only on what is drawn, not on the whole pool. Read the fee list before signing anything, because the cost often hides there. Ask each lender whether the owner must sign a personal guarantee, which is a promise to repay from personal assets if the business cannot. Start small, pay early, and keep the paperwork tidy.

The whole of it

What it is

A friend of mine ran a landscaping outfit for years on his own debit card. Then one wet spring, three clients paid late, and he could not cover the mulch bill. That is the moment a line of credit earns its keep.

Business credit means a company's history of borrowing and paying back. Lenders look at it to decide whether to lend and at what price. The company has its own tax ID number, called an EIN, which the IRS issues for free. Many small owners also have a personal credit file, and lenders often read that file too, since a young company has little record of its own.

There are two main tools. A business credit card lets an owner buy now and pay the bill later. A business line of credit works more like a savings pool you can borrow from. The lender sets a limit, say $25,000. The borrower draws what is needed, repays it, and can draw again.

A term loan is a different animal. It hands over one lump sum, and the borrower repays it in fixed payments over a set time. A line suits uneven cash flow. A term loan suits one big purchase.

How it works

If you are holding a line of credit, the cycle runs in two parts. First comes the draw period, when the borrower may take money out. Then comes repayment, when the borrower pays it back. Some lines are revolving, so repaid money becomes available again. Others close after one use.

Interest is the price of borrowing. On most lines the rate floats, which means it moves up and down with a benchmark rate. The lender must disclose how the rate is set, so ask to see it written down. Fees matter too. Some lenders charge an annual fee, a draw fee, or a fee for keeping the line open and unused. Each one adds to the true cost.

Security is the next piece. A secured line is backed by something the business owns, such as equipment or invoices. If the borrower cannot repay, the lender may take that asset. An unsecured line has no such backing, so the lender leans harder on the owner's credit and often asks for a personal guarantee.

That guarantee deserves a slow read. When an owner signs one, the owner agrees to repay out of personal money if the business cannot. A limited liability company, or LLC, protects personal assets in many situations. A personal guarantee can cut straight through that shield. Know it before you sign.

Reporting is how a business builds its file. Some lenders and vendors send payment records to commercial credit bureaus. Others do not. Ask each one whether it reports, because a loan that never reports builds nothing.

The numbers, and where to find yours

I once watched a baker stare at a loan offer for an hour, circling words. Numbers are easier than words, so let us gather the ones that count.

Start with the interest rate. Some lines carry rates set by a benchmark plus a margin, and the margin is the lender's own add on. Look for the annual percentage rate, often called APR, which rolls interest and certain fees into one yearly figure. Compare APRs between lenders, not just the headline rate.

Next is the credit limit, the most the borrower may have out at one time. Then the fees, which sit in the loan agreement and the fee schedule. Read both. The borrower has a right to see them before accepting.

For the business side, your EIN is on the letter the IRS sent when it was issued. Your personal credit report is free once a year from each of the three major bureaus at annualcreditreport.com, the site the federal government points people to. Commercial credit reports come from separate companies, and many sell them for a fee. Check what each one charges.

If you want a federally backed loan, the Small Business Administration, or SBA, publishes its own program rules on sba.gov. The SBA does not lend directly in most cases. It guarantees part of a loan made by a bank, which can make a lender more willing to say yes. The maximum loan amount for a program is set by the SBA, so for the current cap on the 7(a) program, the figure is the current figure, which the official source publishes each year. Check the date beside it before relying on it.

Your own numbers to gather are simple. Write down your monthly revenue, your monthly bills, your current debts, and the cash you hold. A lender will ask for all of them.

A worked example

Let me tell you about Marisol, who runs a small bakery. Her shop earns about $18,000 a month in sales. Her flour, rent, and wages come to about $15,000 a month. She applies for a $25,000 line of credit with an APR of 12 percent and an annual fee of $150.

One slow month, her oven breaks. The repair costs $4,000. She draws $4,000 from the line and pays it back over four months.

The interest runs like this. At 12 percent a year, the monthly rate is 12 divided by 12, which is 1 percent. In month one she owes interest on $4,000, so 1 percent of $4,000 is $40. She pays back $1,000 of the draw each month, so the balance falls.

In month two the balance is $3,000, and 1 percent of $3,000 is $30. In month three the balance is $2,000, and 1 percent of $2,000 is $20. In month four the balance is $1,000, and 1 percent of $1,000 is $10.

Add it up. $40 plus $30 plus $20 plus $10 is $100 in interest. Add the $150 annual fee. Her total cost for the year is $100 plus $150, which is $250. She borrowed $4,000 and paid $250 to do it.

Notice something. The $150 fee cost more than the interest. A small draw on a line with a flat fee can cost more in fees than in interest. Marisol saw this and asked the lender about waiving the fee. Nobody hands over a discount you do not ask for.

Where it goes wrong

Here is the part I would rather you hear from a friend than learn the hard way. A line of credit feels like free money, and it is not. The borrower has to repay every dollar plus the cost.

One common stumble is mixing personal and business money. When an owner pays business bills from a personal account, the lines blur. A lender, an accountant, or a court may then treat the two as one. Keep separate accounts. It is plain and boring, and it protects you.

Another is the personal guarantee, which I mentioned. Many owners sign one without a second thought. If the business fails, the lender can go after the owner's savings. Know what you are putting up.

Variable rates bite too. A rate that looks fine today can climb. Marisol's 12 percent could become a higher number next year, and her cost would rise with it. Build a little room into the budget.

Then there is the unused line fee, which charges the borrower just for having the line open. And the line itself can shrink or close. A lender may lower a limit or cancel a line, and the agreement usually says when it may do so. Read that clause.

Finally, late payments hurt. A missed payment can dent the business file and, if guaranteed, the personal one. Pay early when you can. It is a small habit with a long reach.

Questions to answer before you leave this page

Do you know exactly how much your business needs, and for what? Have you counted the full cost, including every fee, and not just the interest rate? Does the lender require a personal guarantee, and are you ready to stand behind it with your own money? Is the rate fixed or variable, and could your budget survive if it rose? Does this lender report your payments to commercial credit bureaus, so the effort builds your file? Are your business and personal accounts kept apart? Have you read the section that lets the lender cut or close the line? And what is your plan to repay, written down in plain numbers you could show a friend?