Open credit and line of credit are two ways you or your business can buy now and pay later. Your choice of either method, or both, depends on your creditworthiness, flexibility and the amount of time you need or want to repay.
Uses of Credit
A supplier or seller grants you open credit to order its products. With open credit, you can buy only from the grantor. By contrast, a line of credit allows you to buy goods and services from a variety of providers, but your payments go to a single lender, such as a bank or finance company. Lines of credit can also finance your operating costs and provide cash to keep you afloat in lean times.
The limit on your credit line depends on your credit history and whether the line is secured. In a home equity line of credit, the bank can set your limit -- depending on your creditworthiness -- up to 85 percent of your home's value (after deducting the mortgage). The Small Business Administration says the high credit ceilings on business credit cards can help you finance large purchases.
When you apply for open credit, you'll typically need to furnish information about yourself or your business and bank accounts. Suppliers and vendors likely will ask for commercial references or other businesses that can vouch for your credit history. According to the SBA, grantors of traditional lines of credit will want financial statements, personal and business tax returns and bank account information. The agency says that you can avoid the documentation requirements by getting a business credit card for your line of credit. If you exercise this option, the card company will pull your credit scores.
Backing the Credit
Open accounts are typically not backed by collateral, including the goods sold. Instead, the seller may require the business owner, officers or managers to guarantee payment if the buyer is a corporation. A line of credit can be unsecured or secured. With a home equity line of credit, your house or the equity in it is the collateral. According to the Consumer Finance Protection Bureau, some financial institutions require you to have a checking or other account with them to get a personal line of credit.
With open credit, your entire balance is due on a specified date. Depending on your vendor or supplier, you get a price break if you pay off early. For example, if your invoice says "2/10, n (or net) /30" you have 30 days to pay the purchase price. The seller will give you a 2 percent discount if you pay in full within 10 days after the invoice date.
Interest and Balloons
On lines of credit, the entire loan is not due initially. Some lenders or companies may require a balloon payment, in which you must make a lump-sum payment years down the road to pay off the loan. Whether or not you have a balloon payment, interest accrues on the unpaid balance of a line of credit. The amount of interest and thus your monthly payment can increase if you have a variable interest rate or draw more money from the line of credit. The SBA points out that you have flexibility in paying off the balance early, making the minimum payment or going beyond the minimum.
- Consumer Finance Protection Bureau: What Is a Personal Line of Credit?
- Export-Import Bank of the United States: Small Business: Letter of Credit vs. Open Account
- Johnstone Supply: Application for Open Credit Account
- Apogee Sound International: Terms and Conditions of Sale
- Entrepreneur: Small Business Encyclopedia -- Loans
- Connecticut Department of Revenue Services: PS 96(2) -- The Treatment of Early Payment Discounts
- Federal Trade Commission: Consumer Information: Home Equity Loans and Credit Lines
- Consumer Financial Protection Bureau. "Differentiating Between Secured and Unsecured Loans." Accessed May 11, 2020.
- Nolo. "What Can Creditors Do If You Don't Pay?" Accessed May 11, 2020.
- Federal Trade Commission. "Home Equity Loans and Credit Lines." Accessed May 11, 2020.
Christopher Raines enjoys sharing his knowledge of business, financial matters and the law. He earned his business administration and law degrees from the University of North Carolina at Chapel Hill. As a lawyer since August 1996, Raines has handled cases involving business, consumer and other areas of the law.