Line of Credit vs Loan: What’s the Difference?
You’ve begun looking into business financing, and have come to a fork in the road: line of credit vs loan. They’re two very different types of funding solutions, and their distinctive features will naturally raise some important questions.
What are they?
What’s the difference?
Which is a better fit for your business profile and needs?
Before making the choice to apply for one or the other, you’ll want to get the answers to those questions. Keep reading to get those answers, and much more.
One important note: of course, the type of business will affect the kind of industry loans a business needs, as well as the specific circumstances that business finds itself in. Be sure to weigh your options carefully in order to choose the right funding solution for your business.
What is a line of credit?
A line of credit loan is a flexible financing solution which allows the borrower to use funds on an as-needed basis and up to a predetermined limit. Business lines of credit, more specifically, come in several varieties including:
- Unsecured or secured lines of credit
- Revolving or non-revolving lines of credit
- Startup business line of credit
- Short-term or medium-term lines of credit
Qualifications for a business line of credit vary quite a bit between different loan providers. Some lenders offer lines of credit with terms as short as 3 months, and others as long as 5 years; some will provide credit limits as low as a few thousand dollars, and others upwards of $100,000.
Typically a line of credit loan is revolving, meaning that as funds are withdrawn and repaid, the credit line replenishes so that the funds can continuously be withdrawn and paid back. The biggest advantage that this offers to borrowers is the ability to use the funds if they need to, and lose nothing if the credit line isn’t used. A business line of credit is an ideal backup plan for expenses that pop up unexpectedly and need to be handled quickly.
Ultimately, lenders will offer better terms to businesses that they determine are a lower risk. In other words, businesses that have better credit scores, credit histories, and have been in business longer will typically get better offers.
What is a term loan?
A term loan is a form of funding that lenders provide to borrowers as a lump-sum of money. Business term loans go by many different names, including (but not limited to):
- SBA loans
- Equipment financing
- Long term business loans
- Unsecured business loans
- Invoice factoring
There are differences in the qualifications for term loans as well, depending on both the lender and the borrower. As the name suggests, term loans are limited to a specific period of time. They’re not necessarily long term business loans; term loans through Become can range from 3 months up to 10 years, with amounts as low as $500 and as high as $500,000.
As opposed to a line of credit loan which allows borrowers to withdraw funds when they want or need to, short term or long term business loans provide all of the funds to the borrower in one lump-sum. This can be advantageous if the purpose of the loan is to make a long-term investment. But on the flip side, it means that if for some reason not all of the funds are used, then the borrower is stuck accumulating debt on money that isn’t generating any profit.
While a line of credit loan is flexible and can be used as a backup plan for quick funds, a business term loan is generally recommended to be used with a specific goal in mind that can only get done with those funds.
Who is a line of credit best for?
A line of credit offers a great deal of flexibility to borrowers compared to other types of business loans, which in turn means that businesses in all different industries, of all different ages, and even those with poor credit scores can be candidates. Startup business line of credit? No problem! To reiterate, because the funds provided in a line of credit don’t have to be used, it’s a fantastic form of flexible funding for any business to have on the backburner.
Situations when you’d use a line of credit
There are countless situations where a line of credit would be useful. Generally speaking though, the funds available in a line of credit shouldn’t be used all at once. That’s a fast way to get into an unhealthy amount of debt and also severely limits the flexibility offered by lines of credit – which is the whole point of taking one in the first place! If your goal is to use a large sum of money all at once, you’re better off applying for a term loan.
A few ways to use a line of credit:
- Paying employees
- Small repairs around the place of business
- Renovations
- Cover unpredictable expenses involved in large projects
Any situation where expenses arise unexpectedly, cash flow is limited, or a short-term investment opportunity present itself – a business line of credit can come to the rescue.
Who is a term loan best for?
Term loans are best for businesses that have a precise purpose for taking out a lump-sum of money. While there is certainly a great deal of companies that would be jumping for joy at the opportunity to obtain a large amount of funding all at once, the qualifications are normally stricter for term loans than for lines of credit.
In other words, businesses that have been operating for relatively longer (a number of years) and those that have stronger credit scores are the most likely to be approved.
Become is dedicated to making it easier for small-to-medium sized businesses to get funded. Even if your company hasn’t been around for so long, or has a less-than-perfect credit score, you’ll receive tailored guidance on how to improve your business’s fundability.
Situations when you’d use a line of credit
Since business term loans provide the entire amount of financing all at once, it’s normally the case that the borrower uses the funds predominantly for an individual long-term investment. Within those parameters, the situations when a business would use a term loan can vary greatly.
A few ways to use a term loan:
- Hiring new employees
- Building a brick-and-mortar headquarters
- Purchasing equipment
- Buying a web domain/building a website
When business owners want to take their companies to the next level and the costs are beyond their budget, a term loan is one of the best ways to tackle larger tasks which ultimately help the business grow.
Term loan vs line of credit: which is best for your business?
When attempting to determine whether the best funding solution is a term loan or a line of credit, there isn’t a one-size-fits-all answer. A myriad of factors come into play, including the:
- Intended use for the funds
- Applicant’s credit score
- Business age
- Existing debt
Term Loan Vs Line of Credit: Breakdown
If a simple answer had to be given, then a line of credit loan is an appropriate funding solution for virtually any and every business. Since the funds are available on an as-needed basis and there’s no penalty for not using the credit line, every business should consider taking a business line of credit to have at hand in case of emergency.
On the other hand, term loans are an appropriate funding solution for businesses that not only know how they intend on using the funds but also need the funds in order to reach that intended goal. If your business has a difficult time obtaining a term loan, you should apply for a line of credit which can then be used to improve your financial factors – that will subsequently improve your chances of getting approved for a term loan.
And the winner is…
You! Whether it’s a line of credit or a term loan, the solutions are at your disposal. And, if for whatever reason you find your business is unable to qualify for either sort of funding, Become will provide you with tailored guidance on how to get qualified. With advanced algorithms and dozens of lenders for businesses to potentially match with, Become works round-the-clock to help small-to-medium businesses get funded the smart way.
We hope you find the information in this guide helpful when considering a line of credit vs loan. If you feel that there were any questions which were left unanswered, please feel free to leave a comment. Good luck!
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