Business line of credit: How it works and how to qualify

Published Monday 2 February 2026

Table of contents

• How does a line of credit work?
• Line of credit vs term loan
• How is a line of credit different from a credit card?
• Common business uses for a line of credit
• What you need to qualify for a line of credit
• Secured vs unsecured lines of credit
• How to apply for a line of credit
• Risks of over-using a line of credit
• Managing your business finances with the right tools
• FAQs on business lines of credit

Key takeaways

• Apply for a business line of credit before you need it, as lenders offer better terms when your business shows strong financial health and you have time to compare options.
• Use lines of credit for short-term cash flow gaps and unpredictable expenses, but avoid using them to cover ongoing losses or routine operational costs like payroll.
• Compare secured and unsecured options carefully, as secured lines of credit typically offer lower interest rates and higher credit limits but require collateral like property or inventory.
• Prepare essential financial documents including recent bank statements, balance sheets, and income statements to speed up the application process and improve your chances of approval.

How does a line of credit work?

A business line of credit is a flexible financing tool that gives your business access to funds up to a set limit. You only pay interest on what you withdraw, not the total available amount.

How it works: You can withdraw funds when needed and repay them on your schedule.

Revolving credit: Once you repay funds, you can reuse them without reapplying.

Example of a line of credit

A bank gives you a line of credit with a limit of $50,000. You withdraw $10,000 to buy inventory. You only pay interest on the $10,000 and can still use the remaining $40,000 if you want.

You then need $5,000 for new shop fittings. You can withdraw that before you have paid back the $10,000. The lender charges interest only on the amount you have borrowed.

Interest rates and fees

Interest rates on a business line of credit can be variable, meaning they can change over time. The rate you get often depends on your business's financial health and whether the credit is secured.

Besides interest, look out for other potential costs. Some lenders charge an annual fee to keep the account open, or a draw fee each time you take out money. Understanding all the costs helps you see the true price of borrowing.

Credit limits and borrowing amounts

Your credit limit is the maximum amount you can borrow. Lenders decide this based on your business's revenue, time in business, and credit history, which includes details like credit applications from the past five years, any overdue accounts, and public records. Limits can range from a few thousand dollars to much larger amounts for established businesses.

As your business grows and your financial situation improves, you may be able to ask your lender for a higher credit limit to support your expansion.

Line of credit vs term loan

Term loans provide a lump sum with fixed repayments over a set period. Lines of credit offer flexible access to funds as needed.

Choose a term loan for:

• Large purchases: Buildings, equipment, major investments
• Lower interest rates: Fixed rates typically below line of credit rates
• Predictable repayments: Set monthly payments over defined terms

Choose a line of credit for:

• Cash flow gaps: Cover short-term expenses when revenue is delayed
• Unpredictable needs: Access funds when borrowing requirements vary
• Flexible repayment: Pay interest only on funds you use

How is a line of credit different from a credit card?

Business credit cards are typically unsecured financing with no collateral required. Business lines of credit can be either secured or unsecured.

Key differences:

• Collateral requirements: Credit cards need no collateral; lines of credit may require assets as security
• Interest rates: Credit cards typically charge higher rates due to unsecured nature
• Credit limits: Secured lines of credit often offer higher borrowing limits
• Risk to lender: Lower risk with secured lines of credit means better terms for borrowers

Common business uses for a line of credit

Common business uses for lines of credit:

Cash flow management:

• Seasonal businesses: Cover payroll and overheads during slow periods
• Invoice delays: Use invoice financing or a bridging loan while you wait for client payments
• Opportunity purchases: Take advantage of bulk discounts on inventory

Repayment flexibility:

• No prepayment penalties: Pay lump sums without additional fees
• Interest-only periods: Pay only interest during low-revenue months
• Variable payment amounts: Adjust payments based on cash flow

What you need to qualify for a line of credit

Apply for a business line of credit before you need it. Lenders offer better terms when your business shows strong financial health.

Financial documents required:

• Bank statements: Recent business account activity
• Balance sheet: Current assets and liabilities snapshot
• Income statements: Revenue and expense records

Qualification criteria:

• Business credit history: Established track record of business payments
• Personal credit score: May be required as additional security
• Time in business: Many lenders require 6 months to 2 years of operation
• Revenue requirements: Consistent income demonstrates repayment ability

You can download a free balance sheet template from Xero so you can go to the lender with the information they need.

Secured vs unsecured lines of credit

A secured line of credit is backed by collateral, such as property or inventory that the lender can take if you do not repay the debt. For example, a factory valued at $500,000 with a 65% loan-to-value ratio (LVR) could secure a loan of up to $325,000. Because this reduces the lender's risk, secured lines often come with lower interest rates and higher credit limits.

An unsecured line of credit doesn't require any collateral. This makes it a popular choice for service-based businesses or those without significant assets. However, the lender takes on more risk, so interest rates are usually higher and credit limits are lower.

How to apply for a line of credit

Applying for a line of credit is a straightforward process. Following these steps can help you prepare.

1. Research lenders. Compare different banks and online lenders to find the best rates and terms for your business.
2. Gather your documents. You'll typically need financial statements like your balance sheet and income statement, plus business registration details and bank statements, with lenders often wanting to review records from the past three years.
3. Complete the application. Fill out the lender's application form online or in person. Be prepared to provide details about your business and its owners.
4. Review the offer. Once approved, carefully review the credit limit, interest rate, fees, and repayment terms before you accept.

Risks of over-using a line of credit

Don't use a line of credit to cover ongoing losses or permanent financing needs. This signals deeper cash flow problems that require different solutions.

Warning signs of misuse:

• Routine expense funding: Regularly using credit for payroll or basic operations
• Persistent debt levels: Never paying down the balance significantly
• Loss coverage: Using credit to offset declining revenue

Better alternatives:

• Cash flow analysis: Review accounts receivable and payment terms
• Term loans: Lower interest rates for long-term financing needs
• Business restructuring: Address underlying profitability issues

Managing your business finances with the right tools

A line of credit can be very helpful, but it works best when you have a clear picture of your finances. Knowing your numbers helps you borrow wisely and stay on track. With real-time insights from Xero, you can monitor your cash flow, manage expenses, and see exactly where your business stands.

This clarity helps you plan ahead and make confident decisions about your funding needs. Ready to run your business, not your books? Try Xero for free.

FAQs on business lines of credit

Here are answers to some common questions about business lines of credit.

Is it worth getting a business line of credit?

A business line of credit is best if you want a flexible solution to cover short-term cash flow gaps. If you need a large sum of cash for a major purchase, a term loan is often a better option.

What qualifies you for a business line of credit?

Lenders typically look for a solid credit history, consistent revenue, and at least six to twelve months in business. The exact requirements will vary from one lender to another.

How long does it take to get approved?

Approval times can vary. Online lenders may approve applications in as little as one or two business days. Traditional banks might take several days or even weeks. Having your financial documents organised can help speed up the process.