A smart small business owner knows to build a solid financing plan. That means considering several options and finding out what financing options are right for you. Two great options to consider when going over financing opportunities are business lines of credit and term loans.
In this article, we are going to cover the costs and benefits of business lines of credit and term loans. By comparing the two, hopefully you will have a better idea about which options will work best for 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 is revolving. That means that once you pay back money owed, the line of credit resets. So, for example: if your line of credit is for $100,000 and you spend it all, once you make a payment for $20,000, that money opens back up on your credit line. When you pay on your credit line, your available funds go back up and the amount you owe goes down. When you draw from your credit line, your capital availability goes down and the amount you owe goes up.
A business line of credit is a great option for small business owners with good credit because there are no restrictions. This makes lines of credit perfect for growth opportunities. Maybe you are offered a great deal on some new inventory, or you might come across an opportunity to hire more people for a job. Instead of using cash, you can use a line of credit to bridge gaps in your small business plans.
With a multi-year term loan, a small business borrows one large sum of money and gets it all at once. When setting up terms with a lender, you determine how much money to borrow, how long you have to pay it off, and the interest rate.
Term loans often require very strong credit histories. This means that qualifying for a term loan might be hard for newer small businesses or business owners with lower credit scores. Underwriting is based on the cash flow of the small business, 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. Like with 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 qualification than 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 fixed expenses 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 add up to a deep debt hole fast. A multi-year term loan can be used to consolidate different debt from other loans to manage all money owed into one payment.
Business lines of credit are great for short-term spending. Examples of costs that lines of credit are best for are payroll and unexpected or temporary expenses. When you need quick money to keep your small business at a competitive advantage, a line of credit can be beneficial.
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.