Line of Credit vs. Term Loans

Last Updated Jul 10, 2020 | Published on Nov 6, 2018 | Small Business, Working Capital

A smart small business owner knows to build a solid financing plan. This means examining several options and discovering which financing options are right for you. Two superb sources to consider when going over financing opportunities are business lines of credit and term loans.

Although these two business loan options provide the same benefits – additional working capital – these two financing choices work differently. In this article, we are going to cover the costs and benefits of business lines of credit and term loans. By comparing the two, you will have a clear idea regarding which options will work best for you and your small business.

Business Line of Credit

A business line of credit is basically like a credit card. When you set up the terms for a business line of credit, you determine a dollar amount and length of the terms, which usually covers several years. After that, you can use that money for whatever you want with no restrictions.

A business line of credit can be revolving or non-revolving. Revolving means that once you repay the money you have used, the line of credit resets.  When you pay down your credit line, the funds available to you goes back up. When you draw from your credit line, your capital availability goes down and the amount you owe goes up. Basically, you can withdraw any amount at any time as long as you don’t exhaust your credit limit.

A business line of credit is an excellent option for small business owners with good credit because there are no restrictions. This makes a line of credit perfect for growth opportunities. This is especially true if you are offered a great deal on some new inventory, or you come across an opportunity to hire more people for a job. Instead of dipping into your cash reserves, you can use a line of credit to bridge gaps in your business operation. This way, you won’t have to tap into your business’ finances and face cash flow issues.

Term Loans

With a multi-year term loan, a small business borrows one large sum of money and receives it all at once. When setting up terms with a lender, you determine how much money to borrow, how long you have to repay it, and the rates of interest.

Term loans often require very strong credit histories. This means that qualifying for a term loan might be hard for a newer small business or a business owner with a lower credit score. Underwriting is based on the cash flow of small businesses. So, as long as you can show that your available capital is enough to support your loan payments, there are no restrictions on purchases.

When you set up the terms for a multi-year term loan with a lender, you chose from the repayment and interest rate options available. Much like other loans, the borrower can choose from fixed or variable interest rates. However, unlike some other alternatives for financing small businesses, if the loan defaults, the lender goes after the business owner. Multi-year term loans are a little more restrictive in terms of qualifying than are lines of credit because of the credit status needed.

Comparing Lines of Credits and Term Loans

Business lines of credit and term loans are just a couple of the many financing options available for small business owners. Typically, a business line of credit is going to have lower interest rates than multi-year term loans. But, term loans are generally better for larger purchases or high ticket items that are going to take a while to pay off.

One way that small businesses can take advantage of term loans is to consolidate debt. Many small businesses accumulate debt from credit cards or short term loans, which can quickly become foreboding. A multi-year term loan can be used to consolidate debt from other loan sources, giving you an opportunity to make a single monthly payment.

Business lines of credit are great for short-term spending. Examples of costs that lines of credit are perfect for are payroll and unexpected or temporary expenses. You can also take advantage of a line of credit if you can’t qualify for traditional loans because of a poor credit rating. When you need quick money to keep your small business at a competitive advantage, this type of financing plan is the best option.

Lines of credit and multi-year term loans are just two of the many financing options available for small business owners. When making funding decisions, it’s important to consider the different opportunities and understand the costs and benefits associated with each.

 

ABOUT AUTHOR

Jake

Related Articles

Is Bookkeeping a Difficult Job?

Is Bookkeeping a Difficult Job?

It’s a common misconception that one needs a CPA certification to be a bookkeeper. This is not true. Bookkeeping does entail a lot of math – regular monitoring of cash, paying bills, and tracking...

Share This