Business Lines of Credit vs SBA Loans: An Honest Comparison

Demand for financing is picking up among the small business community. The latest Small Business Credit Survey finds that 43% of employer firms applied for financing in the past 12 months (compared to 40% in 2017) with 42% seeking a business line of credit and 22% applying for loans through the Small Business Administration (SBA).

These popular forms of financing are available from most banks, but how do you know which one is right for you?

If you’re seeking financing to grow your business, here’s a closer look at some of the factors to consider when choosing a line of credit vs. an SBA loan.

If you need funding faster

Sometimes there just aren’t enough funds right when you need it. You might be waiting for a large client to pay their invoice, or you might need to purchase a new piece of equipment to replace a broken one. How you handle situations like these directly impacts the long-term stability of your business.

SBA loans, while popular, aren’t always ideal if you need funds in a hurry.

It’s important to know that the SBA doesn’t directly lend you the funds if you’re approved for a loan. Instead, they provide a guarantee to an SBA-approved lender. These lenders have their own evaluation process which can take weeks to complete. If approved, the loan application must then be authorized by the SBA. The whole process may take between 60 to 90 days before funds are deposited in your account.

In contrast, if you have a pre-approved line of credit in place (which can happen in a matter of minutes) you can access business funds as and when you need them often as soon as the next business day.

If you haven’t been in business long

Access to operational capital is important to younger businesses who lack the cash flow or margins to self-fund growth. How does that affect your choice of financing? If you’re considering an SBA loan, your business should be at least two years old to qualify. Many lenders apply the same requirement to business lines of credit. However, new innovations in fintech are expanding access to credit to businesses who have been in business for a short while.

If you want flexibility in how you spend your funds

If you need a large injection of capital to purchase real estate, new equipment, or buy land, SBA loans can be used for a wide range of expenses up to $5 million. However, during the application process, you’ll need a solid business plan to demonstrate why you need the loan and how you intend to spend the funds, which may limit your options to a very specific purchase.

You can use a business line of credit to fund similar ventures as an SBA loan, but unlike with an SBA loan, there is greater flexibility in how you can use those funds. If approved you can use a line of credit for any business purpose, such as funding equipment, buying inventory, and supporting your hiring, marketing, and other short- or long-term growth plans. 

Although credit limits are lower than most SBA loans, ranging from $5,000 to $500,000, they are revolving, meaning you can tap into them again and again. Once you’ve paid back what you borrowed you still have access to the original approved loan amount for other investments, unlike an SBA loan which has a one-time use.

If your credit score isn’t great

A low credit score is the number one reason for credit denial by banks. According to a recent small business credit survey from the Federal Reserve, it’s also why many business owners receive less than the financing amount they sought.

To alleviate the risk associated with lending to small business, SBA lenders are selective about approving loans. To qualify you will typically need to have high personal and business credit scores and a healthy fiscal record. Your lender may also ask you to put up collateral in order to secure financing.

These strict eligibility requirements can leave many businesses financially underserved. Furthermore, small business owners often dislike using their personal credit for their business because they want to avoid mixing their business and personal finances.  

Your credit score can also factor heavily into your eligibility for a line of credit. However, lenders are responding to the needs of small business owners and finding additional ways to assess small business “lend worthiness”, such as bank account activity or accounting reports. As a result, you now have the potential to access a line of credit with no minimum credit score or collateral requirement (known as an unsecured line of credit)—and, thanks to the power of technology, get a credit decision in minutes.

If you want to avoid fees

If you are hunting for lower fees, it’s wise to compare carefully and ask a lot of questions before deciding.

SBA loans are designed specifically for small businesses and, compared to traditional bank loans, offer lower down payments, longer repayment terms, and refinancing options. Interest rates are also capped by the SBA (although they can still vary and in some instances by high).

How do lines of credit compare? That depends.

The costs associated with lines of credit vary. If you don’t do your research you could get stuck with higher interest rates, withdrawal fees, or maintenance fees—or not. If you want the flexibility and convenience of a line of credit, look for financers who are transparent about their fees so you know what you’re committing to before you agree. You can also find lines of credit that don’t charge application, maintenance, and unused line fees. Some also offer the option to waive fees all remaining fees if you repay early.

The bottom line

As you research your business financing options there’s a lot to consider. Business owners have better financial options available to them than ever before, expanding access to much-needed capital on their own terms.

If you want access to funds quickly, and want the flexibility to spend the funds as and when you need them—on business purchases of your choice—then a line of credit could be the right option.

If you have more time to wait, want a loan for a very specific and singular purpose, have been in business for a while, and have a high credit score, then an SBA loan can make sense.

This guest post was written by Irene Malatesta of Fundbox.