How An Unsecured Line of Credit Works
A “line of credit” refers to an ongoing loan, from which a business may borrow any amount of money up to a certain limit, provided that it pays back the principle on time. A business line of credit offers one a way to access funds fast, and is the most popular source of funding among small businesses. A 2017 survey conducted by Federal Reserve Banks on small business found that of the ones that had applied for some form of funding, 43 percent applied for lines of credit, and of these, a vast majority received approval.
A line of credit can be especially helpful when funds are needed urgently, but it is not meant to be utilized for a project or purchase which necessitates drawing on a large amount. Instead, a line of credit is ideally intended as a “safety net” of sorts, which specifically allows quick access to limited funds. When one requires a source of cash flow to keep their doors open, lines of credit can be very beneficial. As the business does not need to reapply each time it withdraws funds unlike when taking out a normal term loan, there is no bother from the average long-drawn application and approval procedure that comes before a traditional loan.
A secured line of credit means exactly what the name suggests – one that gets drawn on your property or asset. In contrast, to avail an unsecured business line of credit, you would not need to put up anything as collateral. For the uninitiated, collateral is “something” that is pledged to guarantee loan repayment; in an event of default, your lender could legally claim the collateral. Most set it up this way to minimize the risk involved in loaning to a business. Clearly, securing a line of credit with, say, a car or house, would put the borrower at some risk, and make the consequences of defaulting more severe and surer for them. This is something which can make the unsecured line of credit option more attractive to the small business owner.
This is not to say one is always better than the other. An unsecured line of credit can also show relative downsides. For one, it generally tends to come with a higher rate of interest and a lower borrowing limit, as well as a shorter repayment timeframe. While for some businesses these things might be acceptable, others would find them to be the opposite.