How Can a Nonprofit Qualify For and Use a Line of Credit?

One of the most important tools that for-profit businesses have used for decades is a line of credit, and nonprofit organizations are now beginning to recognize that a nonprofit line of credit is an important tool for them to have as well. Nonprofit organizations have always wanted a line of credit, but commercial banks have made it challenging for many nonprofits to qualify for one. In this article, I will cover how a line of credit works, what nonprofits are using their credit line for, and how to qualify for a line of credit from a bank or alternative lender.  

How a Line of Credit Works

A line of credit is a preapproved fixed amount of money that a nonprofit can have access to at any time and for any reason. The credit line often stays in place for 12 months and is renewed yearly. Nonprofits are only charged once they use the credit line; however, some financing institutions will charge a setup and maintenance fee. When nonprofits “draw” funds from their credit line they are charged a small fee or interest each day that the credit line is being used. A credit line is not expensive, especially for the problem that it solves.

Once the line is paid off there are no fees. It is not unusual for nonprofits to use their credit line for a very short time to address a problem, pay the line back, and draw again on the line later.
Most nonprofits use their credit line for emergencies and opportunities. The most often cited use of a credit line is to make payroll when cash flow is down because it is illegal to miss or delay payroll for any reason. Another use of a credit line is to continue important nonprofit programs when a reimbursement check is delayed.

A line of credit is most often used to address a temporary cash-flow problem where certain bills must be paid. Contrary to popular opinion, a line of credit is not used to purchase a building or property and a line of credit should not be used if the amount of money drawn cannot be paid back within 12 months. The other two types of financing outside of a credit line are a commercial mortgage and a term loan.
A nonprofit can get a line of credit from a commercial/local bank or alternative lenders.

How to Qualify for a Nonprofit Line of Credit From Banks

Commercial/local banks and credit unions will look at four key areas to approve a line of credit. Collateral, personal guarantees, credit scores, and financials. 

Collateral

Banks are some of the most conservative institutions around and generally are reluctant to take risks. As a result, banks want collateral so that if they are not paid back, they have an asset that they can sell to make up for the loss. Collateral can be an asset the nonprofit owns or an asset that a donor pledges. Collateral is one of the key stumbling blocks that have stopped nonprofits from getting a bank line of credit. (There are some solutions to not having collateral we will discuss later.)

Personal Guarantees

Banks will want someone to sign on the bottom line that has some credibility and the way that banks will determine credibility is if the individual's personal credit score is often better than 680. On top of this, the signer will be personally responsible for paying the line back if the nonprofit fails on its obligation. 

Financials

Banks also will ask review a nonprofit's financials, usually including 990-tax filings along with income statements, balance sheets, and other financial documents. 

Banks and credit unions have been known to reduce or eliminate their requirements for collateral and personal guarantees if a nonprofit has had a long history with the bank. Banks will also adjust their criteria if the nonprofit’s bank balances and transactions over a long period indicates that it is a stable institution that will be able to pay its debts. However, organizations often must have a champion working for the bank who will support the application. 

One other factor that affects the chances of getting a line of credit from a bank is the economy. In times of a recession, banks are often less willing to approve any type of loan, especially one that is not backed up with collateral. 

How to Qualify for a Nonprofit Line of Credit From Alternative Lenders

One of the main reasons a bank must be very diligent about approving a line of credit and loans is because the bank is using both depositor and government funds. Therefore, banks are regulated by a set of federal government standard rules that apply to both businesses and nonprofits. Those rules can make it hard for nonprofits to get a line of credit from a bank. 

Back in the 2008 recession, many banks stopped lending and alternative lenders filled the void using new technology. Now 80% of all business loans and business lines of credit are set up through online alternative lenders, not banks. These online lenders use private funds and therefore are not bound to one size fits all approval standards. Plus, these alternative lenders are willing to work with smaller size businesses that banks were not set up to handle economically.