A business line of credit empowers small and medium sized enterprises (SMEs) to fund their growth in their way. This fast, flexible financial facility can help businesses better manage their cash flow and ensure long-term success.
However, understanding how line of credit interest works is essential for using this financial solution effectively. Business finance rates can vary from solution to solution, and even from provider to provider.
For custom advice from a ScotPac lending specialist, visit our Business Line of Credit product page and contact us today to learn more.
What is a Business Line of Credit?
To understand how line of credit interest works, it is critical to first understand how this funding solution works.
A business line of credit is a flexible revolving financial facility. It is designed to allow you to withdraw funds whenever you need additional working capital up to a pre-agreed limit.
What does this mean for line of credit interest?
Interest on a business line of credit is only charged on the outstanding balance. In other words, you only pay interest on the funds you have drawn down on and borrowed, rather than your full limit.
This is distinct from a term loan or standard business loan when you pay interest on the full amount owed, regardless of how much you use.
It also is what makes a line of credit such a cost-effective finance solution for SMEs needing to better manage fluctuating cash flow.
Do line of credit interest rates change?
Like all business finance rates, lines of credit with variable interest rates will be subject to fluctuating rates over time. This can depend on a number of macro-economic and market conditions and/or the policy of your lender.
How do you know what your finance interest rate is?
Changes to your interest rate will be disclosed to you by your provider/lender.
However, it is important to continuously monitor your statements and product disclosure documents for any changes in interest rates (as well as fees).
What factors determine the interest rate?
There are a few different factors that can affect an interest rate offered to your business by a lender. These include:
- Creditworthiness
- Time in business
- Cash flow and turnover
- Facility size
- Facility term
- Collateral
- Market factors
Creditworthiness
The stronger your business and personal credit score the easier it is to secure favourable interest rates.
Time in business
The longer your business has been operating, in other words the more established your company and consistent its turnover, the better the interest rate you are likely to receive.
Cash flow and turnover
Businesses with steady and significant turnover, with demonstrably strong cash flow management, are likely to be perceived as lower risk by a lender and thus offered a lower interest rate.
Facility size
The higher the credit limit, the higher the risk for the finance provider. Hence, higher credit limits attract higher interest rates.
Facility term
The same applies to the term of the facility. Longer repayment terms increase perceived risk and thus may be subject to higher rates.
Collateral
Security requirements vary depending on loan size and circumstances.
With property provided as security you can often lock in lower interest rates Market factors
Lenders and finance providers will factor in a number of market benchmarks, such as the cash rate, to help determine the interest rate for your specific line of credit.
What other fees do lines of credit incur?
It is important that you speak directly to your funding provider. However, some potential fees that are common when it comes to lines of credit can include:
- Account-management fees
- Service and set-up fees
- Drawdown (i.e., usage) fees
- Annual fees for facility access
- Inactivity fees
- Late payment penalties
How do you calculate interest on a line of credit?
In most cases, the interest on a line of credit is calculated on a daily basis. However, your business is likely to be billed on a monthly basis.
There is a standard formula for calculating interest:
Outstanding Balance × Annual Interest Rate × (Days in Billing Period / 365)
Let’s take, for example, a situation where you have drawn $50,000 (regardless of your total credit limit). Then say that you have been offered a 10% annual interest rate and that your billing month is the standard 30 days in length.
You can now plug the values into the formula:
Outstanding Balance × Annual Interest Rate × (Days in Billing Period / 365)
50,000 x 0.10 x ( 30 / 365 ) = 410.9589
In other words, when you owe $50,000 through your line of credit facility, you will need to pay $410.96 in interest.
Interested in a line of credit and business finance rates? Contact ScotPac today.
If you would like to learn more about the flexible funds available in a tailored line of credit facility, the ScotPac team is here to help.
As the largest non-banking lender in Australia, we support over 9,300 businesses and have been providing tailored working capital solutions for more than 35 years of experience
Why not enquire today to discover how industry-leading line of credit interest offerings and business finance solutions can help fuel your success?