Business loan vs. line of credit
If you’re someone with bold visions of opening your own business or expanding your existing business you’re probably already thinking about the best way to finance such a project. While there are a lot of options out there for additional streams of cash, the two that typically pop up at this stage are business loans and business lines of credit. There are advantages and disadvantages to each avenue. Let’s take a look at the key differences between a business loan vs. line of credit, see how they might benefit your business, and determine which, if either, is the right one for you and your business.1
What is a small business loan?
So, what exactly is a small business loan? Well, essentially, they’re lump sums of cash provided by lenders to small businesses that are paid back, with interest over time. Depending on your needs or goals, there are many loans available for small businesses ranging from small, short-term loans that are to be paid back in a term of six months to one year all the way up to larger long-term loans with term limits that typically exceed three years.2
Small business loans can come from a multitude of sources. One of the most common places to start is the Small Business Administration, or SBA. This government agency partners with vetted lenders, community development organizations, and micro-lending institutions to bring small business owners and funding together. The organization is also in charge of setting the guidelines and rules of repayment for all lending parties involved.3,4 They’re not the only source for such loans, however. Depending on the type of financing you need, loans can come from banks of all sizes as well as non-profits or even community groups.5
What is a business line of credit?
A small business line of credit is similar to a credit card in that the lender agrees that you are permitted to borrow a certain amount of money. That limit cannot be exceeded, however also like a credit card, you only pay interest on the money you borrowed and as you pay it down you’re able to continue to spend up to your limit repeatedly without issue. This makes access to cash fast and flexible, allowing for continued spending through an extended, ongoing period of growth or expansion.6
Deciding between a business loan or line of credit
So how does one decide between a loan or a business line of credit? There are a few factors that come into play when figuring out what will best fit the bill. Some questions you may want to begin asking might be:
- How large of a loan will you need?
- How long will you need to repay the borrowed funds?
- What will you be using the funding for?
Additionally, make sure to familiarize yourself with some of the criteria that lenders may be reviewing such as your:
- Credit score
- Businesses cash flow
- Business plan and how it relates to when and how the loan will be spent
- Debt to income ratio.5,7
The most common type of short term small business loan is commonly referred to as a working capital loan. This type of loan is usually lent for short durations of time and in small amounts. It’s for everything from paying rent during slower periods of business to paying down higher interest debt. Depending on the lender, sometimes these loans are directly linked to personal credit and can affect your credit score if payments are not made regularly on time.2,5,6
The cycle of borrowing and repaying on a small business line of credit is extraordinarily helpful for longer term projects. For example, to expand a facility or introduce a new product line where unexpected delays or expenses may occur it’s nice to have the flexibility to continue using up to your spending limit and paying it down time and time again.5
There are other types of business loans too. For example, if you’re looking for a larger loan with a longer repayment runway, a good place to start would be looking at small business term loans. These are generally a single large, lump sum loan for things like facility expansion, a lengthy research and development project, or any other large single expense. For the most part, these loans are paid back over the course of three to five or more years and can have both fixed or variable interest rates depending on the lender and factors such as your credit score, cash flow, debt to income ratio, and others.2,5,6
Deciding between a business loan or a line of credit is contingent upon the needs of your business. Review your goals and comfort level prior to borrowing.
Which type of credit is right for your company?
Before reaching out for a line of credit or loan, it’s important to start with a thorough assessment of needs. A detailed business plan with clearly defined short and long term goals is important in making a final decision. There are a lot of options out there for small business owners. You’ll have your pick between large commercial banks, small local banks, SBA-backed loans, and more. There are plenty of options available for either route you chose. Remember to know the requirements as well as advantages and disadvantages for each avenue before applying.
No matter which option you ultimately chose, remember that paying your loans on time is vital to building and maintaining a healthy credit score as well as developing good rapport with banks and lenders with whom you may do business again in the future. If you’re looking for more small business resources, the Business Solutions Center is a great place to start.