Two of the most common financing options for small businesses are term loans and lines of credit. They both fund your business needs, but which one is better for your situation? To help you decide, here is a breakdown of each one, the positive and negative aspects, and when they are most useful for businesses.
What Is a Term Loan?
A term loan is a lump sum of money that you receive at one time and then paid back with equal, regular payments at a fixed interest rate. The word "term" refers to the number of months a business has to repay the loan.
Term loans can be used for purchasing equipment, buying real estate, working capital, and other reasons. Many prefer term loans because it gives them several years to pay off the balance with a predictable payment schedule.
📌 Interested in a business loan? We partnered with Funding Circle to bring you loans up to $500,000.
Pros and Cons of a Business Term Loan
Some of the positive aspects of a term loan include the following: a set payment schedule (same payment amount every month until the loan is paid off), term-loans from online institutions (like Funding Circle) can fund quickly, and term loans can be good options for large projects or expansions.
Some of the negative aspects of a term loan include the following: prepayment penalties (being charged a penalty for paying the loan off early), short-term loans can have higher interest rates, and they often require collateral or a personal guarantee.
What Is a Business Line of Credit?
A line of credit operates similar to a credit card. A lender approves your business for a specific amount, and you draw from it whenever you need to. When you take from a line of credit, you can pay that portion back before taking out more, thus replenishing your available credit.
Lines of credit typically don't have term limits, so if you borrow and pay back the line of credit responsibly, you could potentially have it for as long as you want. Generally, the balance on a line of credit must be paid back within 12 months, sometimes up to 18 months. Many enjoy lines of credit because it offers greater flexibility and longer use than term loans.
📌 Interested in a line of credit? We partnered with BlueVine to bring you lines of credit up to $250,000.
Pros and Cons of a Line of Credit
Some of the positive aspects of a line of credit include only paying interest when you borrow and for the amount that you borrow, having extra cash available when you need it, and they typically don't have term limits.
Some of the negative aspects include being harder to qualify for, having very high interest rates for missed payments, and lenders may file a UCC-lien as collateral.
What Are The Major Differences?
First, term loans have a set interest rate, whereas the interest rate on lines of credit can increase dramatically after missed payment, similar to credit card interest rates.
Second, with lines of credit, you only pay interest on the amount you borrow, whereas, with a loan, you pay interest on the entire loan amount throughout your term period.
Thirdly, with a business line of credit, you can pay it off whenever and draw from it again. With term loans, there are often prepayment penalties if you pay off the loan sooner than the term agreement.
Lastly, many consider loans to be better for expenses with known amounts that will occur in a specific time-frame. Lines of credit are often considered better if you think you'll have several smaller expenses over time.
Which One Is Better For Your Business?
After reading about term loans and business lines of credit, you may have already decided which one is better for your business. If not, here are some more pointers.
A term loan may be preferable if:
- You do not want on-going credit availability
- You want one large lump sum of money
- You know how much you need
- You need funding quickly
- You need more than 12-18 months to pay off the loan
A line of credit may be preferable if:
- You will have several smaller expenses arising over time
- You want access to capital whenever you need it
- You want to have a financial safety-net in place at all times
- You want to be able to re-use the funding
- You will be able to pay your credit balance within 12 months
Business loans and lines of credit both provide you with added capital to meet your financial needs. Loans tend to be better for a one-time project or a series of small projects in a short time-frame. Funding Circle is a good place to look if you are interested in term loans.
Lines of credit tend to be better if you expect to have several smaller expenses over an extended period. In the end, you know your business needs best. BlueVine offers lines of credit starting 4.8% interest if you are interested in a business line of credit.
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