What Is the Advantage of a Secured Line of Credit?

For business owners looking for some financial flexibility, one of the more inviting options is a secured line of business credit. Such a line of credit provides a business owner with the funds to buy equipment, fund special projects, maintain steady business operations, or deal with any financial needs that may arise. Unlike a loan, a line of credit can be used without reapplying each time funds are needed, since a line of credit is a continuous source of finance that is used much like a credit card (yet typically without a monthly bill).

A line of credit can be especially helpful in covering fluctuations in cash flow, as the business owner can use the available funding to maintain working capital until the inventory sells and receivables are collected. By continuing to finance the business at a steady pace, the business owner can keep growing the business. Essentially, by paying back just the interest, a company can keep the line of credit (essentially an advance) in use and leverage the cash on hand.

In contrast to an unsecured line of credit, a secured line of credit is advantageous because it typically allows a business owner to have access to a far greater sum of money at significantly lower interest rates. Credit limits can be 10 times higher for secured credit lines because the business owner is putting up collateral. The most common form of collateral is the company’s current operating assets, which are the accounts receivable and/or inventory. Lenders may prefer accounts receivable to inventory because inventory can be riskier; however, the two often go hand in hand. Unsecured lines of credit are a greater risk to the lender, so the credit line is far more conservative. Most small businesses do not have the track record or business history to obtain an unsecured line of credit, and even those that do often prefer the higher credit limit and flexibility that a secured line of credit offers.

Business owners who are considering a secured line of credit should shop around and compare the offers of various lenders, since terms can and will vary widely. For example, some lines of credit need to be repaid in full after one year; this can slow the business operation, giving the business owner less freedom to use the line of credit to leverage the cash of the company.

Interest rates will also vary, so the business owner needs to compare such rates and weigh them in conjunction with the terms of the overall agreement. Fees, including prepayment fees, may also be part of the agreement. Again, this needs to be factored into the equation when making comparisons, although fees can often be negotiated. There is also the question of the credit limit. A company may typically borrow somewhere between 50 to 80 percent of the amount of eligible accounts, which are accounts that arise in the ordinary course of doing business (usually excluding those that are more than 90 days due and similar outstanding accounts).

For many business owners, a secured line of credit with interest-only payments and flexible terms can be a very useful means of maintaining a positive cash flow while meeting the needs of a growing business.