Small Business Line of Credit
Published 7 August 2026 · Last reviewed 7 August 2026
A business line of credit is an approved limit you draw against as you need it and repay as money comes in, paying interest only on the balance you are actually using. It exists to fund the gap between paying suppliers and being paid by customers.
How a business line of credit works
You are approved for a limit, then draw against it whenever you need cash and repay whenever you have it. Interest is charged only on the drawn balance, not the whole limit, and the facility revolves — repaying frees the room up to draw again without reapplying.
That structure is what distinguishes it from a term loan. A term loan gives you the full amount on day one and charges interest on all of it from day one, whether you needed it that week or not. A line of credit charges you only for the days you were actually short.
Most facilities are reviewed annually rather than running to a fixed maturity, so the limit can be reduced or withdrawn if trading deteriorates. That is worth knowing at the outset: a line of credit is not committed funding you can rely on indefinitely.
Line of credit vs term loan vs overdraft
A line of credit sits between the other two. An overdraft is attached to your trading account and is the most convenient but usually the dearest and the easiest for a bank to pull. A term loan is cheapest per dollar but inflexible. A line of credit is a separate revolving facility with a set limit.
| Line of credit | Term loan | Overdraft | |
|---|---|---|---|
| How you access it | Draw against a limit as needed | Full amount advanced upfront | Trading account goes below zero |
| Interest charged on | Drawn balance only | Full loan balance | Overdrawn balance only |
| Repayment | Flexible; revolves as you repay | Fixed schedule over the term | Flexible, repayable on demand |
| Typical term | Reviewed annually | One to seven years | Reviewed annually, at call |
| Usual cost | Above a term loan | Lowest per dollar | Usually the highest |
| Best for | Recurring, predictable cash flow gaps | A one-off purchase or investment | Small, short, unpredictable shortfalls |
The right choice follows the purpose. Buying a machine is a term loan: the need is one-off and the asset has a life. Covering the 45 days between invoicing and payment is a line of credit. Occasional small overruns are what an overdraft is for.
What it costs — interest, draw fees and undrawn fees
Three charges matter, and only one is the interest rate. There is interest on what you draw, often a line or facility fee on the total limit whether you use it or not, and sometimes a fee per drawdown. A facility can look cheap on rate and be expensive in practice.
The undrawn portion is where businesses overpay. If you are charged a line fee on a $500,000 limit but rarely draw more than $120,000, you are paying to reserve capacity you do not use. Sizing the limit honestly against your actual gap usually saves more than negotiating the rate.
Ask for the total annual cost at your expected average drawn balance, not the headline rate. Two facilities with identical rates can differ substantially once the line fee and drawdown fees are counted at realistic usage.
Establishment and annual review fees also apply on most facilities, and secured lines carry valuation and legal costs on top. None of these are unreasonable, but they belong in the comparison.
Secured and unsecured facilities
A secured line of credit — usually backed by property, sometimes by a debtor book — buys a larger limit and materially better pricing. An unsecured facility is faster to arrange and puts no asset at risk, but limits are smaller and the rate is higher.
Debtor-backed facilities are worth knowing about if your money is tied up in receivables. The limit moves with your eligible invoices, so it grows as you sell rather than being fixed at approval, which suits a business whose gap widens as it grows.
A director guarantee applies to almost all small business facilities regardless of security. That is not the same as a mortgage over your home, but it does mean personal exposure, and it deserves reading rather than signing.
Where the business is trading well and the gap is genuinely temporary, unsecured is often worth the premium to keep property out of it. Where the facility is large or long-standing, security usually pays for itself in pricing.
When a line of credit is the wrong tool
It is the wrong tool when the shortfall is structural rather than timing. A line of credit smooths the gap between outgoings and receipts; it does not fix a business that is not profitable, and drawing on it to cover losses converts a trading problem into a debt problem.
It is also wrong for funding a long-lived asset. Buying equipment on a revolving facility ties up your working capital headroom for years and costs more than the equipment finance built for it — and leaves you without the buffer when a real cash flow gap arrives.
The warning sign is a facility that never returns to zero. A healthy line of credit fluctuates: drawn when you are waiting on customers, repaid when they pay. One that sits permanently near its limit has become a term loan you are paying line-of-credit pricing for, and should be refinanced as one.
Finally, it is a poor fit where the limit is being sized to what a lender will approve rather than to what the business needs. Available credit is not free capacity — it carries a fee, and it invites use.
How to apply
Work out the limit you actually need before you approach anyone. A lender will happily approve more, and you will pay for it. Size it to your peak gap plus a modest buffer, not to your annual turnover.
FAQs
Do I pay interest on the whole limit or only what I draw?
Interest is charged only on the drawn balance. Most facilities also carry a line fee calculated on the total limit whether you use it or not, so an oversized limit costs money even when it sits idle.
How is a line of credit different from an overdraft?
An overdraft is attached to your trading account and lets it go below zero; a line of credit is a separate facility with its own limit that you draw from deliberately. Overdrafts are more convenient for small unpredictable shortfalls but usually cost more and are repayable on demand.
Can the lender reduce or cancel my limit?
Yes. Most facilities are reviewed annually, and the limit can be reduced or withdrawn if trading deteriorates or covenants are breached. That is why a line of credit should not be treated as committed funding you can depend on indefinitely.
Is a line of credit a good way to fund equipment?
Generally no. Equipment has a long life and is better matched to equipment finance secured against the asset, which is usually cheaper. Using a revolving facility ties up your working capital headroom for years and leaves nothing available when a genuine cash flow gap arrives.
What limit should I ask for?
Size it to your peak working capital gap plus a modest buffer, not to what a lender will approve. Because line fees are charged on the whole limit, an oversized facility is a standing cost, and available credit tends to get used.
General advice warning: this page provides general information only. It does not take into account your objectives, financial situation or needs, and it is not personal credit, tax or financial advice.