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A line of credit allows your company to borrow and repay funds according to its cash needs. Credit lines are different than regular loans because they permit repeated draws and repayments, instead of giving your company a large sum of money upfront and requiring installment payments over an extended period of time. Credit lines can be either secured or unsecured. Each type of line has its own advantages and disadvantages, so consider your options carefully before obtaining financing.
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Collateral for Secured Credit Lines
The main difference between secured and unsecured lines of credit is the use of collateral. With a secured credit line, the borrowing company must pledge its own property as collateral for the loan. If it is unable to make the required repayments, the lender may seize the property as a way to recover some of its losses. There is no such security for an unsecured credit line, which is why most banks impose different rules on this type of loan.
Application Process Differences
Because the risk to the lender is so much higher with an unsecured line of credit, your company must have extremely good credit to qualify for this type
of financing. Some lenders may ask for a personal guarantee from the owners if the company's financial statements are not sufficient to qualify for approval on their own merit. Even a personal guarantee may not be enough if the owners do not have good individual credit.
Restrictions on Credit Line Amount
Lenders may also limit the amount of an unsecured credit line as another method of reducing risk. This is especially true for small businesses that have not had time to establish much of a credit history. A bank may be willing to offer unsecured credit, but it typically will be a small line until it has built a long-term relationship with the company.
Terms May Differ
If you choose an unsecured credit line, you typically will pay more interest unless your company has a stellar credit rating and an existing relationship with your bank. Depending on the terms of the line and your company's financial health, the spread between an unsecured line and a secured line can be 1 to 3 percent. The length of the term also may be reduced for an unsecured credit line, so the bank does not expose itself to risk for an extended period of time.