Business line of credit: what it is and how it works

Published Tuesday 21 April 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?
• Secured vs unsecured lines of credit
• Common business uses for a line of credit
• What you need to qualify for a line of credit
• How to apply for a line of credit
• Risks of over-using a line of credit
• FAQs on business lines of credit

Key takeaways

• Apply for a business line of credit before you need it, as lenders offer better rates and terms when your business is in strong financial health rather than under pressure.
• Utilize a business line of credit for short-term, unpredictable expenses like covering cash flow gaps or seasonal slowdowns, and choose a term loan instead for large, one-off purchases such as equipment or property.
• Recognize the warning signs of over-reliance on a line of credit, such as regularly maxing out your limit, making interest-only payments, or using it to cover routine operating costs like rent and wages.
• Choose between a secured or unsecured line of credit based on your assets, as securing the credit with collateral like property can unlock lower interest rates and higher borrowing limits.

How does a line of credit work?

A business line of credit gives your business access to funds up to a set limit, which you can draw from whenever you need. You only pay interest on what you withdraw, not the total available amount.

This type of financing works as revolving credit. You withdraw funds when needed, repay them on your schedule, and reuse the available balance without reapplying. It's similar to how a credit card works, but typically with lower interest rates and higher limits.

Example of a line of credit

Here's how a business line of credit works in practice.

A bank approves your business for a $50,000 line of credit. You withdraw $10,000 to buy inventory and pay interest only on that $10,000. The remaining $40,000 stays available.

Later, you need $5,000 for new shop fittings. You can withdraw that amount before repaying the first $10,000. The lender charges interest only on what you've borrowed, which is now $15,000.

Interest rates and fees

Interest rates on a business line of credit are typically variable, meaning they can change over time. The rate you receive depends on your business's financial health and whether the credit is secured or unsecured.

Beyond interest, watch for these common fees:

• annual fee: a charge to keep the account open each year
• draw fee: a fee each time you withdraw funds
• maintenance fee: ongoing charges for account administration

Understanding all costs helps you calculate the true price of borrowing.

Credit limits and borrowing amounts

Your credit limit is the maximum amount you can borrow. Limits can range from a few thousand dollars to several hundred thousand for established businesses, though facilities exceeding $1 million typically require banks to carry out annual reviews.

Lenders set your limit based on:

• revenue: your business's consistent income
• time in business: how long you've been operating
• credit history: credit applications from the past five years, overdue accounts, and public records

As your business grows and your financial situation improves, you can ask your lender to increase your credit limit.

Line of credit vs term loan

A term loan and a line of credit serve different purposes. Term loans provide a lump sum with fixed repayments over a set period. Lines of credit offer flexible, ongoing 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?

A business line of credit and a business credit card both offer flexible borrowing, but they work differently. Credit cards are typically unsecured and require no collateral. Lines of credit can be either secured or unsecured, which affects your rates and limits.

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

Secured vs unsecured lines of credit

Secured lines of credit are backed by collateral, such as property or inventory that the lender can claim if you don't repay. Because this reduces the lender's risk, secured lines typically offer lower interest rates and higher credit limits, with lenders generally willing to lend up to 80% of the value when residential property is used as security.

For example, a factory valued at $500,000 with a 65% loan-to-value ratio could secure a line of credit up to $325,000.

Unsecured lines of credit don't require collateral. This makes them popular 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.

Common business uses for a line of credit

A business line of credit works best for short-term, unpredictable expenses rather than large one-off purchases. Here are the most common uses.

Cash flow management:

• seasonal gaps: cover payroll and overheads during slow periods
• invoice delays: bridge the gap while waiting for client payments, or explore invoice financing or a bridging loan
• bulk purchases: take advantage of supplier 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 payments: adjust repayment amounts based on cash flow

What you need to qualify for a line of credit

To qualify for a business line of credit, you'll need to demonstrate your business's financial stability and ability to repay, which is crucial given that up to one in four fail when applying for small business loans. Apply before you need funds, as 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: most lenders require six months to two years of operation
• revenue requirements: consistent income that 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.

How to apply for a line of credit

Applying for a business line of credit typically takes a few days to a few weeks, depending on the lender. Here's how to prepare.

1. Research lenders. Compare banks and online lenders to find the best rates and terms for your business.
2. Gather your documents. Prepare financial statements, business registration details, and bank statements. Most lenders want records from the past three years.
3. Complete the application. Fill out the lender's form online or in person with details about your business and its owners.
4. Review the offer. Check the credit limit, interest rate, fees, and repayment terms carefully before accepting.

Risks of over-using a line of credit

A line of credit is designed for short-term needs rather than ongoing expenses. Using it to cover routine costs or persistent losses signals deeper cash flow problems that require different solutions.

Failing to repay unauthorised credit within 90 days means the exposure must be considered to be in default.

Watch for these warning signs of misuse:

• continuously maxed out credit: regularly using your full credit limit without paying down the balance
• making minimum payments only: paying only interest without reducing the principal amount borrowed
• relying on credit for operating expenses: using the line of credit to cover regular costs like rent, utilities, or wages
• extending repayment periods repeatedly: constantly requesting extensions or refinancing without addressing underlying 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. Get one month free.

FAQs on business lines of credit

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

What's the difference between a business line of credit and a business loan?

A business line of credit gives you flexible access to funds up to a set limit, and you only pay interest on what you withdraw. A business loan provides a lump sum upfront with fixed repayments over a set period. Lines of credit work better for unpredictable expenses, while loans suit large one-off purchases.

How quickly can I access funds from a line of credit?

Once approved, you can typically access funds from your line of credit immediately or within one business day. The approval process itself usually takes a few days to a few weeks, depending on your lender and the completeness of your application.

Can I pay off my line of credit early?

Most lines of credit allow early repayment without penalties. Check your agreement for prepayment terms, as some lenders may charge fees for early closure of the account.

What happens if I don't use my line of credit?

You won't pay interest on unused funds, but you may need to pay annual or maintenance fees to keep the account open. Check your agreement for specific fees that apply even when you're not actively borrowing.

How does a line of credit affect my business credit score?

A line of credit can help build your business credit score when you make timely repayments and keep your credit utilisation low. However, maxing out your credit limit or missing payments can damage your score.