A commercial line of credit is a revolving pool of business funds a lender commits to you up to a set limit, so you can draw cash when you need it, repay it when revenue comes in, and borrow against the same limit again. You pay interest only on what’s outstanding, not on the full commitment. That makes it a tool for smoothing cash flow and covering short-term needs, not a substitute for a term loan you’d use to buy a building or a piece of equipment.
How the Revolving Structure Works
The credit agreement sets a commitment period, which is how long the line stays open, and within it a draw period, during which you can freely tap and repay funds. If you have a $500,000 line and draw $100,000, you pay interest on the $100,000, not the half-million. As you pay down principal, your available credit climbs back toward the limit and is ready for the next draw. That cycle can repeat continuously throughout the life of the facility.
This structure fits short-term, recurring needs: bridging the gap between invoicing a customer and paying a supplier, funding a seasonal inventory buildup, covering payroll during a slow month, handling an unexpected repair. A term loan hands you a lump sum and a fixed repayment schedule; once you pay a term loan down, that money is gone until you apply for a new one. A line replenishes itself.
What a Line of Credit Actually Costs
Most commercial lines carry a floating interest rate tied to a published benchmark. The two most common are the Prime Rate and the Secured Overnight Financing Rate (SOFR), a benchmark published daily by the Federal Reserve Bank of New York.1Federal Reserve Bank of New York. Secured Overnight Financing Rate Data The lender adds a spread. A rate quoted as “Prime plus 1.50%,” at a Prime Rate of 6.75%, works out to 8.25%.
Interest is calculated on the average daily balance. The lender multiplies each day’s outstanding balance by the daily rate and totals it at the end of the billing cycle. Draw $200,000 on the first, pay $100,000 back on the fifteenth, and the first half of the month accrues on $200,000 while the second half accrues on $100,000.
Beyond interest, several fees shape the true cost:
- Origination fee: a one-time charge when the line is established, typically 1% to 3% of the total credit limit.
- Unused line fee: an annual charge on the portion of your limit you haven’t drawn, usually 0.25% to 1%. On a $500,000 line with $200,000 drawn on average, you’ll pay this fee on the remaining $300,000.
- Annual or maintenance fee: a flat fee to keep the line open, often under $200 per year, charged whether or not you use it.
The unused line fee is the one that catches borrowers off guard. The lender has committed capital for your benefit even when you aren’t drawing on it, and you pay for that commitment. Asking for a limit far above what you actually need means paying for unused capacity all year, so right-sizing the line matters.
Secured, Unsecured, and the Personal Guarantee
The biggest structural choice is whether the line is secured by collateral. That one decision drives the rate, the maximum limit, and how much paperwork you’ll handle.
A secured line requires you to pledge specific business assets. The most common collateral is accounts receivable and inventory, an arrangement called asset-based lending. Real estate, machinery, and equipment can also qualify. Because the lender has a tangible fallback, secured lines come with lower rates and higher limits. The lender won’t advance the full face value of what you pledge, though. Advance rates on eligible receivables commonly run 70% to 85%, and some lenders go up to 90% for strong business-to-business receivables; inventory advances typically top out around 65% of book value.2Office of the Comptroller of the Currency. Asset-Based Lending – Comptrollers Handbook A business with $1 million in receivables shouldn’t expect a $1 million line. The borrowing base will land closer to $700,000 to $850,000.
An unsecured line relies entirely on the borrower’s creditworthiness.3U.S. Small Business Administration. Unsecured Business Funding for Small Business Owners Explained These are reserved for well-established companies with strong balance sheets, solid profitability, and clean credit histories. Without collateral behind the debt, the lender compensates with a higher rate and a lower limit.
Here is where many owners misread their exposure: even on a line issued to your LLC or corporation, lenders routinely require the owners to sign a personal guarantee. If the business can’t repay, the lender can pursue your personal assets, including savings, investments, vehicles, and in some cases your home. The entity shield does not protect you from a guarantee you’ve signed. And if the business files for bankruptcy, that filing does not eliminate the personal guarantee. Only your own personal bankruptcy or a negotiated release from the lender ends that exposure.
What Lenders Will Ask For
Approval is documentation-heavy. Expect to provide at least three years of historical financial statements — balance sheets, income statements, and cash flow statements — plus three years of federal business tax returns. You’ll also need current accounts receivable and accounts payable aging reports, which show how quickly customers pay you and how your own bills are stacking up. Most lenders want 12- to 24-month cash flow projections modeling how you’ll draw and repay under different scenarios.
Three financial ratios tend to drive the decision. The debt service coverage ratio measures whether your cash flow covers your 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 shrink the limit or kill the application. The current ratio confirms you can meet short-term obligations without leaning entirely on the new line.
For secured lines, the lender will also run a Uniform Commercial Code search to see whether another creditor already holds a lien on the assets you’re pledging.4National Association of Secretaries of State. UCC Filings A prior lien puts the new lender in a subordinate position, which often forces a restructuring of the collateral or ends the deal.
Drawing, Repaying, and the Cleanup Requirement
Once the line is active, drawing is simple. You initiate a draw through the lender’s online platform or a wire request, and the money usually lands in your operating account within one business day. The amount drawn immediately starts accruing interest at your floating rate.
Monthly payments typically cover accrued interest from the previous period. Principal repayment varies. Lines secured by receivables often require principal paydowns as the invoices backing the draw get collected. Working capital lines frequently include a cleanup requirement: a provision that forces you to bring the outstanding balance to zero for a set stretch, commonly 30 to 90 consecutive days during the year.5Federal Reserve. Branch and Agency Examination Manual – Commercial Loans The cleanup proves to the lender you’re using the line for genuine short-term needs rather than as permanent financing. Fail it, and you’ve triggered a covenant violation. Plan your cash cycle around it.
Covenants and What Default Looks Like
The credit agreement contains covenants that keep you accountable to the financial profile that got you approved. Affirmative covenants are things you must do: deliver updated quarterly and annual financial statements on schedule, maintain adequate property and casualty insurance, pay taxes on time, and keep the business in good legal standing. Missing a reporting deadline is a surprisingly common way to trigger a technical default.
Negative covenants restrict what you can do without the lender’s written consent. Common examples include taking on additional debt beyond a specified threshold, selling major assets outside the normal course of business, or exceeding a cap on annual capital expenditures.
Breaching any covenant is an event of default, as is missing a payment, failing a cleanup, or suffering a material adverse change in your financial condition. Default gives the lender the right to accelerate the loan, demanding immediate repayment of the entire outstanding principal.6Legal Information Institute. Acceleration Clause On a secured line, the lender can seize and liquidate the collateral. If the collateral doesn’t cover the balance, or the line was unsecured, the lender can sue for the deficiency, and the personal guarantee puts your personal assets on the table. The lender can also add legal fees, appraisal costs, and collection expenses to what you owe.
Some lenders will negotiate a forbearance agreement for a curable default, often in exchange for additional fees or tighter terms. They aren’t required to. The leverage shifts to the lender the moment you’re in default, so the better protection is open communication at the first sign of trouble.
Is the Interest Deductible?
Interest paid on a commercial line of credit is generally deductible as a business expense, which lowers the effective cost of borrowing. A federal cap limits how much business interest you can deduct in a year, however. Under Section 163(j) of the Internal Revenue Code, the deduction can’t exceed your business interest income plus 30% of your adjusted taxable income.7Office of the Law Revision Counsel. 26 US Code 163 – Interest Anything disallowed in the current year carries forward.8Internal Revenue Service. Questions and Answers About the Limitation on the Deduction for Business Interest Expense
Small businesses are exempt from the limitation if average annual gross receipts over the prior three years are at or below an inflation-adjusted threshold: $31 million for the 2025 tax year, with the 2026 figure expected to adjust slightly upward.8Internal Revenue Service. Questions and Answers About the Limitation on the Deduction for Business Interest Expense Most businesses using a line for working capital fall well under that threshold 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 partial deferral of the deduction changes the after-tax cost of borrowing.
If You Can’t Qualify Conventionally: SBA CAPLines
Businesses that can’t clear a conventional lender’s bar may find a path through the SBA’s CAPLines program, which sits under the SBA’s 7(a) loan guarantee umbrella. 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 makes approval more accessible for smaller or less established companies.
CAPLines come in four varieties:9U.S. Small Business Administration. Types of 7(a) Loans
- Seasonal CAPLine finances the buildup of inventory, receivables, or labor costs ahead of a peak sales period.
- Contract CAPLine covers the direct costs, overhead, and administrative expenses tied to one or more specific contracts.
- Builders CAPLine provides construction or rehabilitation financing for small general contractors building residential or commercial property for resale.
- Working CAPLine is an asset-based revolving line for businesses that can’t meet the credit standards for longer-term financing, with repayment tied to the cash conversion cycle.
Maximum maturity on a CAPLine is 10 years, except Builders CAPLines, which are limited to 60 months plus the estimated construction timeline.9U.S. Small Business Administration. Types of 7(a) Loans The SBA guarantee generally brings rates below a fully conventional line, though the application involves additional SBA-specific paperwork and processing time.
Renewal Is Not Automatic
Commercial lines are not permanent. Most carry a one-year commitment that renews annually, though some run longer. As renewal approaches, the lender re-underwrites much the way they did originally: updated financial statements, fresh aging reports, a look at your covenant compliance history.
If your performance has slipped, your DSCR has fallen, or you’ve had covenant issues, the lender can reduce your limit, raise your rate, tighten covenants, or decline to renew. The worst time to find out your line won’t renew is when you’re counting on it to fund a seasonal ramp-up, so treat renewal preparation as year-round discipline rather than a scramble at the end.
If a line is not renewed or you close it, any outstanding balance becomes due under the payoff terms in the agreement. For secured lines, the lender releases its UCC filing and lien once you’ve paid in full. Keep documentation of the release. Stale UCC filings can create problems the next time you look for financing.