If you need an influx of capital in your business, there are several different types of financing you can rely on. Two of the more traditional options include business lines of credit and business term loans.

Deciding between a business line of credit and a loan generally comes down to what you need for your business, as well as the terms you want for paying back the debt. Here’s what you need to know about both options and how to choose the right one for your business.

What Is a Business Loan?

A business loan, also typically referred to as a term loan, is a form of installment credit. This means that you’ll receive the loan amount upfront. That amount is then amortized over a set repayment term to give you equal monthly payments to repay what you owe.

Depending on what you need, there are a few different types of business loans from which you can choose. 

Short-term loans may have a repayment period ranging from three to 24 months and can be used for various working capital needs, such as buying inventory, supplies, furniture, and more.

Long-term business loans will often have terms ranging from three to 10 years, or sometimes even longer. These loans are often used to help expand your business by giving you the funds you need to make major investments in your products or services, equipment, and more.

Business loans are available from traditional banks, credit unions, and online lenders. You can also get a term loan that’s partially guaranteed by the Small Business Administration (SBA).

For term loans from banks and credit unions (including SBA loans), the requirements to get approved are generally strict. 

This means you’ll need to have an operating history of a few years or more, an established business credit history, and strong revenues. In many cases, you may also be required to provide collateral or, in the case of equipment financing, put money down.

In exchange for the tighter requirements, you can generally enjoy lower interest rates and fees, as well as longer repayment periods with more affordable payments.

If you’re looking for a short-term business loan from an online lender, eligibility criteria can be less stringent, which can work better for small businesses that are newer or don’t yet have a strong business credit history. 

The trade-off, of course, is that you’ll typically end up with higher interest rates and fees as well as shorter repayment periods.

What Is a Business Line of Credit?

A business line of credit is a form of revolving credit, which functions differently than an installment loan.

Instead of getting a lump-sum payment upfront, business lines of credit offer you a credit line that you can use over and over again — similar to a credit card. 

You can borrow up to a set limit, but you only have to pay interest on the amount that you’ve borrowed rather than the full credit limit.

There are generally two different periods with a business line of credit: a draw period and a repayment period. 

During the draw period, you can take draws from your credit line, and you’ll typically make interest-only payments on those draws during that time. That said, you can pay off the principal balance and reborrow it for other purposes.

Once the draw period ends, you’ll enter the repayment period. At the start of the period, your balance will be amortized over a set period of time, during which you’ll make regular monthly payments as you would with a business loan.

The main difference is that lines of credit may have fixed or variable interest rates, whereas term loans typically only have fixed rates.

Lines of credit can be short or long-term in nature, depending on your needs and creditworthiness. As with term loans, you can get them from banks, credit unions, and online lenders. 

Lines of credit from banks and credit unions typically offer better terms, but you’ll also need to meet stricter standards for approval.

In contrast, online lenders that offer lines of credit may charge higher interest rates and have shorter repayment terms. 

This type of financing is best suited for small businesses that have short-term capital needs but also want the ability to borrow on an ongoing basis instead of just once.

Differences Between a Business Line of Credit and a Business Loan

There are several differences between business lines of credit and business loans. Understanding these differences can help you better determine which is the right fit for your small business.

Purpose

The primary reason you’d pick a term loan over a line of credit is if you only need to borrow money once. Regardless of the reason, you’d get this loan if you don’t anticipate needing an open line to more credit access in the near future. 

Business loans are also more commonly used for big investments, such as equipment or machinery. 

On the flip side, a business line of credit may be the better choice if you want ongoing access to a revolving credit line. 

You can get this same arrangement from a business credit card, but lines of credit may offer much higher credit limits. Additionally, they give you more flexibility with how you can access your funds. 

Interest Rates

With a small business term loan, you’ll typically have a fixed interest rate, which means your rate and monthly payment won’t change for the life of the loan.

In contrast, business lines of credit may come with a fixed or variable interest rate. There may also be lines of credit that allow you to convert a balance with a variable rate over to a fixed rate with a set repayment term.

If you’re stuck with just a variable interest rate though, it will fluctuate over time with market rates, which means it could end up being more expensive.

Repayment Terms

With a term loan, you’ll have fixed monthly payments for the duration of the loan’s repayment schedule. This makes the process more straightforward, and you’ll know what your monthly payments will be at the start of the contract.

With a line of credit, though, you’ll just have a minimum monthly payment throughout the draw period, similar to a credit card. The payment won’t be fixed because you’re generally just paying interest, and it will be dependent on how much your outstanding balance is for that month.

Once the draw period ends and the repayment period begins, though, you’ll have a more predictable monthly payment that includes both principal and interest.

Loan Amounts

Depending on where you look and the size of your business, you can get both term loans and lines of credit in the millions of dollars. In general, it’s easier to get a larger term loan than a line of credit. 

What’s more, some banks may be less interested in offering smaller loans, but you may be able to get a line of credit for the amount you need.

What’s Better: A Business Loan or Line of Credit?

Ultimately, neither a business line of credit nor a business loan is inherently better than the other. It all depends on what you need and your goals for the future. Here are some questions to ask yourself to help you determine which is the better option for you and your company:

• How much do I need to borrow? Depending on how much money you need, either option may help you meet your needs. But if you need a large long-term loan, a line of credit may not be the best choice. On the other hand, if you don’t need to borrow a lot, you may be better off with a business line of credit.
• How do you plan to use the money? If you have a specific reason for borrowing money for your business and only need to borrow once, a term loan is likely the better fit between the two. But if you simply want open access to borrowing money as you need it over the coming months or years, a business line of credit will give you the flexibility you need.
• How does your cash flow look? If you can handle predictable monthly payments based on a fixed interest rate and set repayment term, consider a small business loan. However, if you want some more flexibility with lower monthly payments in the near term, a line of credit that has an interest-only payment period could be the better choice.
• What does your creditworthiness look like? You can get both term loans and lines of credit with good, fair, or even bad credit. But a variable interest rate that starts out high can ultimately cost you a lot more than one that starts out low. In that case, a term loan may be a better choice. Even if the rate is high, it’s fixed, so you don’t have to worry about it going up anymore.

As you try to decide which financing option is better for you, take your time to consider these and other questions to find the best fit. 

Does a Business Line of Credit Affect Your Credit Score?

As with most other forms of business financing, a business line of credit can impact your business credit scores. 

While there are different scoring models for businesses, many of them consider your payment history, mix of credit, and your credit utilization rate, among other factors.

As long as you pay your bills on time, you won’t have to worry about your business credit getting dinged. 

You’ll also want to try to avoid borrowing too much of your available credit. If your utilization rate — the percentage of your credit limit that you’re using at a given time — is too high, it could potentially hurt your business credit scores.

This is because it could indicate that you’re having trouble meeting your everyday expenses without the help of financing. It could also mean that you don’t have the cash flow necessary to support another loan or line of credit in the future.

But as long as you use your line of credit wisely, it can help improve your business credit history instead of hurting it.

The Bottom Line

If you’re trying to decide between a business line of credit and a loan, take your time to consider the strengths and weaknesses of each option to determine which is best for you. At the same time, consider other forms of financing that could help meet your needs. 

Alternatives may include microloans, vendor net 30 accounts, invoice financing, invoice factoring, crowdfunding, and more.  

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