What exactly is a line of credit?
Simply put, with a line of credit, you get permission to go into the bank’s red. In agreement with the bank, the bank will assign you a limit within which you can deposit and withdraw money from your business bank account. This way, you provide yourself with more financial leeway in situations where this is necessary, and you ensure more flexibility.
When is a line of credit attractive?
Applying for a line of credit is an attractive option in various situations. Think, for instance, of companies that want to invest in new equipment, companies that depend on seasonal sales, as well as companies that have to deal with long payment terms from customers. In all these cases, a line of credit can be the financial injection needed to get through a financially challenging time.
When applying for a line of credit, consider the following situations:
- Investments in the business
- Purchasing inventory
- Seasonal work
- Outstanding invoices
How does a line of credit work?
Applying for a line of credit is possible with several banks. The credit will be linked to your business bank account. Before you can apply for your credit, the bank will check your business for a number of things:
- Current annual figures
- The amount of the desired loan.
- The reason/purpose of the application.
- Any other current loans.
When you apply for a line of credit, the bank will ask you to provide some form of security and guarantee. Generally, this is done in two different ways. First, it is possible to put up your business premises, debtors or stock as collateral. In addition, a personal guarantee is also possible, whereby you guarantee a certain amount with your private assets, savings or home.
Once all preconditions have been approved by the bank, your overdraft application is a fact. From then on, the bank will reserve an amount agreed with you, which you can withdraw whenever you want. In a way, you decide when you will be (legally) in red. For many entrepreneurs, the current account credit is a convenient solution, but it is important to know the disadvantages and costs of the credit. After all, what does it actually cost?
What does a line of credit cost?
The cost of a line of credit consists of the interest you pay on the credit. This interest rate varies between banks and situations, and therefore depends on a number of things. Among others, the current financial situation of your company and the various guarantees you can present play a role in the amount of interest to be paid. Generally, the interest rate is between 4 and 10 per cent. What interest rate you should pay is determined individually. Is your company financially sound, and can you offer sufficient collateral? Then the interest rate will be closer to 4 per cent than the 10 per cent you will pay when you are in more dire financial straits.