Business Lines of Credit: What to Watch for Before You Sign

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1. Feature: Business Lines of Credit: What to Watch for Before You Sign (4 min)

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Business owners are getting flooded with line of credit offers. Mixed in with legitimate options from banks, credit unions, and American Express are high-fee online products dressed up to look like real lines of credit. Some are factoring arrangements. Some contain hidden collateral grabs. Some give the lender access to your checking account. Many owners sign quickly because of cash needs or the marketing feels urgent.

A real line of credit can help a business. It smooths timing, prevents unnecessary stress, and creates breathing room. The challenge is telling the difference between a true line of credit and everything else now being sold under the same name.

This article explains the key differences, the risks most owners miss, and the practices that protect you long before you reach the closing table. The Pro Tips give you moves that experienced operators use to keep control of their cash.

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What a Line of Credit Is Designed For

A line of credit exists to help you bridge short periods where outflows and inflows do not line up. You draw only when needed. You repay when revenue arrives. It is not meant to plug financial holes or replace good management.

Local banks and credit unions offer straightforward versions of lines of credit. American Express offers predictable pricing and very fast approvals if you already have a personal AMEX card. Both are safer than unknown email solicitors and some online lenders that advertise instant money and bury the expensive terms in small print.

Pro Tip: Trace the last year of your cash flow and mark times when timing created stress on your business. Ask, is your business seasonal, plagued by “slow-pay” customers, or simply undercapitalized?

Factoring Is Not a Line of Credit

Many online “LOC” offers are not lines of credit at all. They are factoring agreements. Factoring means selling specific invoices at a discount. The company then collects from your customer. It is expensive, rigid, and useful only in narrow industries. It is not a true revolving credit. It is not flexible.

A simple test tells you what you are being sold.

Pro Tip: Ask one question of the deal: Are you being asked to pledge or sell individual invoices? If yes, you are looking at factoring, no matter what the marketing says.

The Hidden Risk of Cross Collateralization

Cross collateralization is the quiet danger in small business lending. It allows a lender to use other accounts or assets you hold with them as security for the line of credit. In practice, it can give the lender the right to freeze or sweep funds from your checking account during a moment of strain for your business.

This risk appears most often with banks and credit unions because owners typically keep their primary business checking account with the same institution. When you sign a line of credit with that same institution, buried language can give the bank power over the cash you rely on every day.

Pro Tip: Before signing a new LOC, identify every business account of yours that are with the lender. Assume the lender can use those accounts to pay down the line unless the documents say otherwise.

How Owners Manage This Risk in Practice

Many business owners take the line of credit from their local bank because the relationship feels safe. After the line is opened, they open an additional operating checking account at another institution and limit the original bank’s visibility and access to daily cash. The risk is reduced.

This strategy works, but only if you handle the transition carefully and didn’t agree in the LOC documents to maintain your sole operating account at the bank while the LOC was available to your business.

The Terms That Matter Most

You do not need to read loan documents like a lawyer. You do, however, need to understand four areas clearly enough to explain them in plain English.

Interest and fees. Look for simple rate structures without surprise charges for draws, renewals, or adjustments.
Personal guarantee. Expect it and understand when and how it can be enforced. Ask for written clarity.
Collateral. Identify whether the line is secured or unsecured, then look for any language linking this loan to other obligations with the same lender.
Financial Covenants. These specific loan requirements must match how your business already operates. If you cannot meet them easily, the line will likely create more stress than it removes.

Pro Tip: Translate every major term into a single sentence. If you cannot do that, you need clarification before you sign.

A Process That Keeps You Safe

The safest lending process is slow, structured, and owner driven.

Request the full documents before agreeing to anything. Read them when you are not rushed. Highlight anything unclear and ask for explanations in writing. Written answers protect you if questions arise later.

Have your own attorney review the documents. Never rely on the bank or credit union’s closing attorney. They represent the lender.

Compare one or two competing offers. Benchmarking keeps you grounded and prevents you from accepting terms aimed at owners under pressure.

Decide where your business checking account will live. The bank that holds your operating cash holds leverage. If you can keep your operating account separate from the bank that gives you the LOC, you will always be better off.

The Bottom Line

A line of credit is a clean, simple tool when it is truly a line of credit and when the lender relationship is structured carefully. Factoring is different. Cross collateralization hides real hazards. Where your operating account lives matters as much as the loan terms.

Try to move slowly. Ask direct questions and get answers before signing. When you do, the line becomes a reliable support rather than a source of future trouble.

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