In an unsecured line of credit, you do not have to provide a collateral such as a movable or an immovable asset. Instead, a fixed annual fee is charged depending upon the offered credit line. Some lenders even offer free usage for the first year and start charging from the second year onwards.
Contrary to this, a collateral is required for a secured loan and is mostly followed in developing countries. The most commonly used collaterals are the company's operating assets such as investments and accounts receivable.
While dealing with business financing, an unsecured line of credit serves as the best option and provides for the temporary financial needs of the growing business. However, there are both pros and cons of availing these funds.
You have the advantage of borrowing money anytime (as per your need) by simply writing a check. It is more flexible than loans, as there is no restriction while accessing funds. Another advantage is that you can even repay the money in lump sum, as per your convenience.
As long as you pay the outstanding bills, you can repeatedly use your credit line and also save yourself from the hassle of re-applying for it. It is as convenient as using a credit card in which you can access funds instantly, whenever the need arises.
The interest rate is much lower than that charged for a credit card. This depends upon the lender; usually, it is between prime minus one percent (-1%) to prime plus 6 percent (6%).
The credit limit offered in this type of credit is less than that of a secured line. Secured funds typically offer ten times more money than the unsecured credit line. It is due to the fact that the latter poses a greater risk to the lender.
One major disadvantage is that due to its ease of use (like credit cards), many people may land into severe debt issues over a period of time if they are not diligent with their repayments.
It is to be noted that not everyone is eligible for these funds; one needs to meet certain criteria for qualification such as two years in business, and a good credit score and revenues. The lender also checks the financial status of the applicant and can deny credit, if he/she is found to have a previous record of bankruptcy.
In case, the applicant has just started his business (not completed two years), there is a possibility that he may get a minimum credit line.
One word of advice while starting a business is to apply for an unsecured line of credit, as it is the best way to finance the routine and unexpected expenses with minimum interest rates. While applying for these funds, check for the interest rate, grace period, annual fees, and additional charges.