Lines of Credit: Online Lenders vs. Traditional Banks
Small business lending has never been so full of different options as it is today. For business owners, that’s a good thing. The explosive growth of the alternative lending industry has led to more access to credit for small business owners that the traditional banks had been turning away, for sure. But that’s not at all.
Alternative lending has also been changing the way those typical loan products we’ve all known and loved (or not) actually work. For example, take your standard line of credit. Depending on whether you’re looking at a line of credit from a traditional bank or an alternative lender, you might be dealing with two pretty distinct loans.
Refresher Course: What is a Line of Credit?
Before we tackle the main differences, let’s remind ourselves what a line of credit is.
Just speaking of the basics, a line of credit, or revolving credit, is an amount of capital you can dip into when you need or let lie when you don’t. If you take a certain sum out to pay for inventory, equipment, payroll, or whatever it is you need cash for, then you’ll just have to pay interest on what you used… And once you pay it off, those funds go back into your credit limit. In many ways, they operate similarly to a business credit card.
While lines of credit can have their downsides, they’re generally very flexible and useful financial cushions for dealing with cash flow slowdowns or emergencies.
Traditional Banks vs. Alternative Lenders
Now that we’ve got that down, we can look at the major factors that distinguish lines of credit from banks and alternative lenders.
In general, banks try to lend to more predictable small business owners. They take fewer risks, and in the aftermath of the 2008 financial crisis banks, tightened their restrictions even further—lending to only the most conservative investments. While they’ve relaxed a little in the past few years, younger or smaller businesses still have trouble making their strict standards.
Alternative lenders, on the other hand, actively cater to the underserved small business owner. While completely new companies, non-profitable businesses, or owners with challenged credit histories might still find some trouble, many more small business owners can find a loan to help their business grow. This isn’t specific to lines of credit, but it’s still an important difference to keep in mind.
The flipside is that alternative lenders charge more for borrowed money, though. Banks have the lowest interest rates around, but alternative lenders need to compensate for their higher risk investments and flexibility—and that compensation takes the form of costlier cash.
A bank line of credit might have interest rates at or below your typical credit card, for example, while an alternative line of credit could range between 7% and 25%—with neither including any possible sign-up or withdrawal fees, or anything else that might contribute to a higher APR.
As you might expect, banks usually give out lines of credit with higher credit maximums. There’s plenty of overlap here—many alternative lines of credit break $1 million while plenty of bank lines of credit go down to $10,000—but, in general, banks give out bigger loans for cheaper. They’re just much, much harder to qualify for.
Both banks and alternative lenders offer unsecured and secured lines of credit. But let’s dive a bit into what exactly that means.
Unsecured just means that a line of credit isn’t tied to any particular bit of collateral. Unsecured bank lines of credit tend to be a bank’s smallest offer—since, naturally, it’s the riskiest.
Banks also offer lines of credit secured by working equipment and inventory, real estate, or even certificates of deposit—which is just money you can’t withdraw and reinvest for a period of time. Some issue blanket liens to collateralize their larger lines of credit, too. So in other words, if you want to take out a $1 million line of credit, you’ll probably need seven figures’ worth of equipment, real estate, or other assets the bank can anchor onto—and make a claim to, in case you default.
Alternative lenders rely more heavily on unsecured loans, but some lenders offer lines of credit backed by inventory, equipment, or even accounts receivable. Invoice-based lines of credit can seem a little complicated, but they effectively let you get paid immediately—even if your customers tarry with their checkbooks. On the whole, alternative lines of credit are a bit more out-of-the-box.
Banks might be the bigger hitters, but alternative lenders definitely win at the racetracks. They’re faster and more efficient underwriters—as even J.P. Morgan realized when they partnered with OnDeck—and they’re much quicker to offer funding. Partly this comes with the territory of looser eligibility standards, but mostly it’s because alternative lenders focus much more on superior algorithms and technology that lets them automate more of the processes.
The line of credit is one of the most sought after (if not the most) loan product available to business owners. If you go to an online lender looking for a line of credit similar to what you'd find at the bank, don't be surprised if what you're offered looks a bit different. Either way, lines of credit make for a great safety net for any small business, and is a smart credit opportunity for most small business owners to seek.