A commercial line of credit is a revolving business loan that gives your company access to a set pool of funds you can draw from as needed, repay, and draw again, with interest charged only on the amount actually outstanding. It sits alongside your operating account as a working capital cushion: when receivables lag payables, you pull what you need; when customers pay, you repay and the available balance climbs back to your limit. That reusable structure is what separates it from a term loan and makes it the standard tool for managing short-term cash flow gaps.
How It Differs From a Term Loan
A term loan delivers a lump sum on day one, repaid in fixed installments. Once paid down, the money is gone unless you apply for something new. A commercial line of credit works like a reusable reservoir. Draw $100,000 against a $500,000 line and you pay interest on $100,000, not the full commitment. Pay it back and the $100,000 is available again. That cycle repeats throughout the commitment period, which is the total window during which the line stays active.
The fit follows from the structure. Revolving credit suits recurring, short-term needs: bridging the gap between customer payments and supplier bills, funding a seasonal inventory buildup, covering payroll during a slow month, handling an unexpected repair. Term loans fit one-time capital purchases where you know the exact amount up front, like equipment or real estate.
What It Actually Costs
Most commercial lines carry a floating interest rate tied to a published benchmark. The two common benchmarks are the Prime Rate and the Secured Overnight Financing Rate, or SOFR, published daily by the Federal Reserve Bank of New York.1Federal Reserve Bank of New York. Secured Overnight Financing Rate Data Your lender adds a spread on top. A rate quoted as “Prime plus 1.50%” against a Prime Rate of 6.75% comes to 8.25%.
Interest accrues on the average daily balance. The lender multiplies each day’s outstanding balance by the daily rate, then totals the cycle. Draw $200,000 on the first, repay $100,000 on the fifteenth, and you pay interest on the full amount for two weeks and on $100,000 for the rest of the month.
Three fees typically sit on top of the interest:
- An origination fee, charged once when the line is established, usually 1% to 3% of the credit limit.
- An unused line fee, charged annually on the portion of the limit you haven’t drawn, typically 0.25% to 1%. On a $500,000 line where average usage runs $200,000, this fee applies to the $300,000 you didn’t touch.
- An annual or maintenance fee to keep the line open, often under $200, charged whether you use the line or not.
The unused line fee is the one that surprises borrowers. The lender has reserved capital for you whether you draw or not, and asking for a limit far above what you actually need means paying for that unused capacity every year. Right-sizing the line matters.
Secured, Unsecured, and the Personal Guarantee
Whether the lender requires collateral drives most of the deal terms: interest rate, credit limit, and paperwork.
Secured Lines
A secured line requires you to pledge specific business assets. The most common collateral is accounts receivable and inventory, an arrangement known as asset-based lending. Real estate, machinery, and equipment can also qualify. Because the lender has a tangible fallback, secured lines carry lower rates and higher limits.
The lender won’t advance the full value of the collateral. Advance rates account for the risk that assets lose value or prove hard to collect. Eligible accounts receivable commonly draw advance rates of 70% to 85%, with some lenders reaching 90% on strong business-to-business receivables. Inventory typically advances at up to 65% of book value.2Office of the Comptroller of the Currency. Asset-Based Lending – Comptrollers Handbook A business with $1 million in receivables should expect a borrowing base closer to $700,000 to $850,000, not the full million.
Unsecured Lines
An unsecured line rests entirely on the borrower’s creditworthiness rather than pledged assets.3U.S. Small Business Administration. Unsecured Business Funding for Small Business Owners Explained These go to well-established companies with strong balance sheets, solid profitability, and clean credit histories. Without collateral, the lender charges a higher rate and offers a lower limit.
The Personal Guarantee
Even when the line is issued to your business entity, lenders routinely require the owners to sign a personal guarantee. That signature is where business owners underestimate their exposure. If the business can’t repay, the lender can pursue your personal assets: savings, investments, vehicles, and in some cases your home. An LLC or corporation does not insulate you from a personal guarantee you signed. And if the business itself files for bankruptcy, that filing does not eliminate the guarantee. Only personal bankruptcy or a negotiated release from the lender ends the exposure.
What Lenders Want to See
Approval is documentation-heavy. Lenders want a full picture of where the business has been and where it’s going.
Financial Documentation
Expect to provide at least three years of historical financial statements: balance sheets, income statements, and cash flow statements, along with three years of federal business tax returns. Current accounts receivable and accounts payable aging reports show how quickly customers pay and how obligations are stacking up. Most lenders also require 12- to 24-month cash flow projections showing how you plan to draw and repay under various scenarios.
The Ratios That Drive the Decision
A few metrics carry most of the weight. The debt service coverage ratio, or DSCR, tests whether cash flow can cover debt payments with room to spare. Most lenders want at least $1.20 to $1.25 in operating cash flow for every $1.00 of debt service. A high total-debt-to-EBITDA ratio signals you’re already heavily leveraged and can push the limit down or trigger a denial. Liquidity ratios like the current ratio confirm you can meet short-term obligations without leaning on the new line.
Collateral Review
For secured lines, the lender’s review extends to the collateral. Real estate and equipment need current third-party appraisals. The lender runs a Uniform Commercial Code search to check whether another creditor already holds a lien on what you’re pledging.4National Association of Secretaries of State. UCC Filings A prior lien makes the new lender subordinate, which often kills the deal or forces a restructuring of the collateral. When receivables serve as collateral, the lender will look hard at customer concentration and your history of bad debt.
Drawing and Repayment
Once the line is active, access is straightforward. You initiate a draw through the lender’s online platform or by wire request, and the funds usually land in your operating account within one business day. The draw immediately adds to your outstanding principal and starts accruing interest at your floating rate.
Repayment reflects the revolving structure. Monthly payments typically cover accrued interest from the prior period. Principal repayment varies by line type. Lines secured by receivables often require principal paydowns as the specific invoices behind the draw are collected. Working capital lines commonly include a cleanup requirement, meaning you must bring the outstanding balance to zero for a set stretch, often 30 to 90 consecutive days each year.5Federal Reserve. Branch and Agency Examination Manual – Commercial Loans The cleanup proves you’re using the line for genuine short-term needs, not as permanent financing. Failing it can be treated as a covenant violation, so build your cash cycle around it.
Any principal you repay becomes available to borrow again, up to the committed limit, without a new application.
Covenants and Ongoing Compliance
The credit agreement doesn’t end at approval. It contains covenants, the ongoing requirements that hold you to the financial profile that got you approved. Violate them and the whole arrangement can unravel.
Affirmative covenants are things you must do: deliver quarterly and annual financials on schedule, maintain adequate insurance, pay taxes on time, and keep the business in good legal standing. Missing a reporting deadline is a common way to trigger a technical default.
Negative covenants restrict what you can do without written consent. Common examples: taking on additional debt above a set threshold, selling major assets outside normal operations, or exceeding a cap on capital expenditures. These exist because the lender underwrote a certain financial picture, and these actions would change it.
A breach of either type is an event of default. Default gives the lender the right to accelerate the loan and demand immediate repayment of the entire outstanding balance.6Legal Information Institute. Acceleration Clause Lenders will often negotiate a cure period or forbearance for minor technical violations, but they aren’t required to. Leverage shifts entirely to the lender the moment you’re in default.
What Default Actually Triggers
Default is broader than missing a payment. Covenant violations, a failed cleanup, or a material adverse change in your financial condition can each trigger it. Once declared, consequences escalate fast.
Acceleration is the immediate tool: the lender demands the outstanding balance in full. On a secured line, the lender can seize and liquidate the pledged collateral. On an unsecured line, or if the collateral falls short, the lender can sue for the deficiency. If you signed a personal guarantee, your personal assets are exposed. Legal fees, appraisal costs, and collection expenses typically get added to the total.
Some lenders will negotiate, particularly when the default is curable and the business is otherwise viable. A forbearance agreement can buy time in exchange for fees or tighter terms. Relying on that goodwill isn’t a strategy. Building a cash reserve for covenant compliance and communicating with the lender at the first sign of trouble are the real protections.
Interest Deductibility
Interest paid on a commercial line of credit is generally deductible as a business expense, which reduces the effective cost of borrowing. A federal limitation caps how much business interest you can deduct in a given year.
Under Section 163(j) of the Internal Revenue Code, the business interest deduction cannot exceed business interest income plus 30% of adjusted taxable income for the year.7Office of the Law Revision Counsel. 26 US Code 163 – Interest Any disallowed portion carries forward to future tax years rather than disappearing.8Internal Revenue Service. Questions and Answers About the Limitation on the Deduction for Business Interest Expense
Small businesses are exempt from the limit if their average annual gross receipts over the prior three years fall at or below an inflation-adjusted threshold, set at $31 million for the 2025 tax year.8Internal Revenue Service. Questions and Answers About the Limitation on the Deduction for Business Interest Expense Most businesses drawing on a commercial line for working capital fall well under that cap and can deduct their full interest expense. Larger businesses should model the 163(j) calculation with a tax advisor before committing to a line size, because a partial deferral changes the after-tax cost of borrowing. For tax years beginning after December 31, 2024, taxpayers may again add back depreciation, amortization, and depletion when calculating adjusted taxable income, effectively raising the 30% ceiling.9Internal Revenue Service. IRS Updates Frequently Asked Questions on Changes to the Limitation on the Deduction for Business Interest Expense
SBA CAPLines If You Can’t Qualify Conventionally
Businesses that can’t qualify for a conventional line may find a path through the SBA’s CAPLines program, part of the 7(a) loan guarantee framework. The SBA doesn’t lend directly. It guarantees a portion of the loan made by a participating bank, which reduces the lender’s risk and opens approval to smaller or less established companies.
CAPLines come in four varieties, each aimed at a different working capital need:10U.S. Small Business Administration. Types of 7(a) Loans
- Seasonal CAPLine, which finances inventory, receivables, or labor buildup ahead of a peak sales period.
- Contract CAPLine, which covers direct costs, overhead, and administrative expenses tied to one or more specific contracts.
- Builders CAPLine, which provides construction or rehabilitation financing for small general contractors building residential or commercial property for resale.
- Working CAPLine, an asset-based revolving line for businesses that can’t meet the standards for longer-term financing, with repayment tied to the cash conversion cycle.
Maximum maturity on a CAPLine is 10 years, with the Builders CAPLine limited to 60 months plus the estimated construction timeline.10U.S. Small Business Administration. Types of 7(a) Loans The SBA guarantee often produces lower interest rates than a fully conventional line, though the application involves additional SBA paperwork and a longer approval timeline.
Renewal Isn’t Automatic
Commercial lines of credit are not permanent. Most carry a one-year commitment period that renews annually, though some run longer. As renewal approaches, the lender re-evaluates you much the way they did at origination: updated financials, fresh aging reports, and a review of covenant compliance during the prior year.
Renewal isn’t guaranteed. Deteriorating financials, a slipped DSCR, or covenant issues can lead the lender to reduce the limit, raise the rate, add stricter covenants, or decline to renew at all. The worst time to find out is when you’re counting on the line to fund a seasonal ramp. If the line isn’t renewed, any outstanding balance becomes due under the payoff terms in the agreement, and for a secured line, confirm the lender releases its UCC filing once you’ve paid in full. Stale UCC filings can create problems the next time you seek financing.