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What’s involved with a line of credit?

Often, when huge financial bills hit at once, most people and business owners are unprepared to come up with the needed funds. For example, perhaps you’re suddenly faced with unexpected medical bills at the same time you’re building a house or planning a wedding for your daughter. That’s when it helps to have a line of credit. Here’s what’s involved in a line of credit and how it differs from a revolving line of credit.

What Exactly Is a Line of Credit?

Simply put, a line of credit is a financial plan for undertaking unpredictable, exceptionally large expenses. Also known as a credit limit or credit line, a line of credit gives borrowers the maximum amount of money that a bank is willing to lend a person or business without needing more approval. For instance, often small business owners use a line of credit to take out more than one loan, such as for upgrading their facilities or buying equipment, rather than having to apply and be approved for each individual loan.

Unlike a traditional loan, a line of credit doesn’t give an individual or business owner one huge lump of money. It’s very similar to a credit card because you’re able to use credit when there’s a need for paying for items that are impossible to pay for at the time you buy them. However, the interest rates involved on most lines of credit are low, which is not the case for most credit cards. Also, the limits are generally high.

What is a Revolving Line of Credit?

A revolving line of credit is a type of line of credit. Also called “revolving account”, revolving credit is a term referring to a credit report account that has a credit limit that’s determined by a lender. Just as a line of credit, a revolving line of credit is a financial agreement that’s between an individual or business and a lending firm.

In a revolving line of credit, you’re allowed to decide the amount that will be charged that’s within that limit, besides the amount you’ll have to pay off each month. It works similarly to a credit card. A common example of revolving credit is an HELOC (home equity line of credit). It helps to have one or more credit card accounts that are in good standing as this can serve as proof that you’re a good credit risk. Just remember that you can only charge the amount that you’re able to repay in full each month.

When you have revolving credit, you have the choice of either carrying your balance over from one month to the next month or paying off the balance in full at the close of a billing cycle. When a balance is carried over from one month to the next one, it’s known as “resolving” the balance.

A Line of Credit vs. Revolving Credit

Although a line of credit is very similar to revolving credit, there’s one primary difference. Unlike a revolving line of credit, a line of credit doesn’t replenish once payments have been made. This means that after a borrower has paid down a line of credit, the account is closed, so it can’t be reopened. In order to receive more credit, an individual or business has to reapply for an entirely new line of credit. The odds of obtaining additional credit are considerably better when the initial loan was used wisely.

Considerations and Warnings

  • Frequently, corporations and small businesses use a revolving line of credit to protect them from cash flow issues or for financing capital expansion.
  • Both revolving and non-revolving credit are available in two versions: secured and unsecured credit.
  • While a secured credit line involves using collateral, such as a home, car or other assets for securing a loan, an unsecured line of credit doesn’t require collateral.
  • Although an unsecured loan involves less paperwork and is quicker, it can be more difficult to obtain as you’ll need to have a better credit score since your loan won’t have collateral as security.

Do you need a personal loan or a business loan? Don’t hesitate to call Jim Plack. As a credit and lending expert, I have more than 25 years of experience, working in the banking and lending industry. Please contact us and find out more about our wide range of services.

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What is DSR and how do I optimize it?

In the world of corporate finance, you’re going to hear a lot about DSCR, otherwise known as Debt Service Coverage Ratio. If you have ever bought a home, you might have had your debt to income ratio calculated, and this is a similar number, just on an individual level.

Knowing your DSCR and how to optimize the DSCR will allow you to obtain financial loans more easily and also get better interest rates.

What is the DSCR?

The DSCR will measure your cash flow that is available to pay off all of your current debt obligations. The ratio will identify your operating income as the debt obligations due within a single year. This will include:

  • Lease payments
  • Sinking-fund payments
  • Principle
  • Interest

DSCR is calculated simply. Take your net operating income and divide it into your total debt service.

If the number is greater than 1, then you have sufficient income to pay off all of your debt obligations. If you do not, then it can spell big trouble. Anything less than 1 means you have negative cash flow. You don’t want to be in this kind of situation because it means you’re unable to make a full year of your annual debt payments.

How to Improve Your DSCR

There are a lot of things you can do in order to improve your DSCR. Before you become too concerned about a number that is less than 1, remember that not all lenders will calculate the same way. For example, income taxes are complicated because the interest payments are tax deductible. The principle payments, however, are not.

You can start by monitoring your DSCR. Your income may increase and decrease throughout the year and thus your DSCR will change. The goal is to maintain a level of 1.25 or higher. If it shows you drop below this number at any point, you can then take action.

Increase your cash flow. This sounds easier said than done, but if you have a lot of outstanding debt, you have to do something in order to improve your current financial situation. Perform a good forecast so you can see where your cash flow is and whether it’s realistic to follow for the rest of the year. If you work on an accounts receivables basis, be sure you have a reliable collections system that works – and file disputes quickly.

To increase cash flow, it should also be a companywide priority. This means exploring ways to cut back spending so more flows down to the bottom line. It also means looking at ways to generate more revenue, such as adding a new service or product. Exploring your demographic is vital, too, as you may be missing out on an audience that you hadn’t thought of before.

You should also look at the lenders you use. If higher interest rates are in place, you will spend more on interest than on principle. This means you’re going to take longer to pay down the debt, leaving you with a problematic DSCR for a longer amount of time.

If you can choose lenders with lower interest rates, or even asking lenders if they can drop your current APR, it might be what’s needed to pay down some of the debt faster. This will leave less debt for you to calculate in against your total annual revenue.

Understanding your DSCR is an important part of being financially responsible, regardless of who you are. When the number calculates to less than 1.25, begin working on ways to improve the state of your finances so you don’t run into lending issues or any financial problems throughout your journey.

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Why Boutique Lenders Are Your Friend

Banks are said to approve less than a fifth of requests for loans when it comes to small businesses. Not only is it a matter of creditworthiness, there are a lot of “standards” a business has to meet in order for a bank to determine if it is a potential client.  With alternatives expanding, small businesses now, more than ever, may be able to find a credit source to build their products and compete in the market. Here are a few reasons why one alternative, boutique loans, are a great financial resource for small businesses with plans of future and continual growth.

More Personalized and Customized To Meet Your Needs

Whereas banks often require a significant collateral in order for a creditworthy small business to secure a loan, boutique lenders may or may not require collateral and often approve potential clients at a higher rate.  Not only that, boutique lenders are constantly transforming in order to address market demands.  What does this mean?  Boutique lenders often offer more personalized and customized loans to meet a small businesses needs.

Quicker Response Rate

Boutique lenders, which are private lending sources, also often have a quicker response rate. Why?  Boutique lenders address the needs of “niche groups” meaning one lender may specialize in small business loans and another in personal loans.  They also use a variance of lending methods in order to meet client where they want to be met.

Less Hassle and Credit Check

Speaking of client needs, boutique loans are also noted to be less hassle and often will not require a credit check.  Small businesses that simply do not qualify for a bank loan because of some issues in small print are turning to boutique lenders as a source of financial safety today more than ever.  With many credit products out on the market today, it is worth knowing which one works for your business in the long term.  Still not sure Why Boutique Lenders are Your Friend?  If you are a small business that finds itself struggling to acquire a loan from a traditional bank, check out the research on smaller- less institutionalized and bureaucratic-  boutique lenders and see how this alternative may be able to help your business grow. Knowing what is out there today will get you where you need to be when you need it most.