Small business owners need money to pay for things like bills and supplies or to expand their business bigger. This article talks about two ways to get money—one is called a line of credit, and the other is a term loan. They work differently, and we’ll explain them in easy words so you can pick what’s good for you. A business line of credit lets you make money when needed, and a term loan gives you all the money at once to pay back slowly. It’s not about telling you to borrow—it’s about helping with problems like not having enough cash or big costs. Small Biz Heroes knows small businesses have these issues and gives simple tips. We’ll go step by step so you understand and choose what helps your business most.
Why Do Money Tools Matter?
Money is very important for a small business. Without enough, you can’t pay workers or buy things you need. Sometimes, sales are slow, or something breaks and needs fixing fast. This can make running a business hard. A small business loan or a line of credit can give you money when you need it. A loan is good for big purchases, and a credit line helps with small expenses. Knowing how they work helps you pick the best one. This keeps your business safe and helps it grow.
Understanding the Differences Between Business Line of Credit and Term Loan
Business Line of Credit
A business line of credit lets you access funds whenever needed, up to a set limit. Think of it like a refillable bucket—you take money, repay it, and use it again. Interest is charged only on the amount you borrow.
For example, if you have a credit line of around $20,000 and use about $5,000 to buy new chairs, you still have around $15,000 left. Once you repay the $5,000, your full limit is restored. This option is helpful when you’re unsure how much or when you’ll need money.
Term Loan
A term loan provides a lump sum that you repay in fixed amounts over a set time, like a few years. It’s similar to a home loan—you receive the full amount upfront and pay it back gradually.
For instance, if a bakery needs about $30,000 for an oven, the owner can take a loan and make estimated payments of around $600 per month for several years. This loan is ideal for large, planned expenses.
How These Two Financial Options Are Different?
A line of credit and a term loan both give you money, but they work in different ways. Knowing these differences can help you pick the right one for your business.
Getting the Money
- A line of credit lets you take money as needed, up to a limit. You can use it again after repaying.
- A term loan gives you all the money at once. If you need more later, you must apply again.
Paying It Back
- A line of credit lets you borrow money and pay it back whenever you’re able to.
- A term loan has fixed monthly payments until it’s fully paid.
Interest Costs
- A business line of credit has a changing interest rate, often around 6% to 18%.
- A term loan has a steady interest rate, usually around 4% to 12%.
How Long You Can Use It
- A line of credit can stay open for years if renewed.
- A term loan ends once all payments are made.
A Business line of credit is great for ongoing small needs, while a term loan is better for big purchases with fixed payments. Choosing the right one helps your business manage money better.
When to Use a Line of Credit
A line of credit is best when things change a lot. Small business owners deal with surprises—maybe a customer pays late or a machine breaks. This gives you money fast without a big commitment. Use it for:
- Small Cash Problems: Pay bills if sales are low this month.
- Quick Needs: Buy extra stock for a busy day.
- Things That Come Up: Fix a leak or cover rent if cash is short.
A coffee shop owner might take $4,000 from a $10,000 line to buy beans for a festival, then pay it back in two months. This flexibility helps small businesses stay safe.
But watch out—interest can go up, and there might be small fees, like around $100 a year, to keep it.
When to Use a Term Loan
A term loan is good for one big thing you know you need. It’s easy to plan because payments don’t change. Use it for:
- Big Stuff: Buy a truck, a computer, or a new sign.
- Growing: Open another store or make more products.
- Long Use: Get something that lasts years, like a freezer.
A mechanic might borrow $25,000 for tools and pay $500 a month for five years. The tools help him work more, and he knows the cost each month.
The problem? You must pay every month, even if money is tight. And you get all the cash at once, even if you don’t need it yet.
Costs of a Business Line of Credit vs. a Term Loan
When borrowing money, there are extra costs besides interest. Here’s what to expect:
Line of Credit:
- You pay a yearly fee (approx. $100-$500) to keep it open.
- Each time you take money, there’s a small fee (approx. $20-$50).
- Interest rates can be high, especially for new businesses.
Term Loan:
- There’s a one-time start-up fee (approx. 1%-5% of the loan). For example, around $200 for a $20,000 loan.
- Some lenders charge a fee if you pay it off early.
- Interest rates are usually lower if you have good financial records.
For example, keeping a $10,000 line of credit open might cost around $150 per year, while a $10,000 term loan could have an approx. $300 upfront fee. If you only need money for a short time, a business line of credit might be better. If you need a larger amount for a long time, a term loan could save you money.
How to Qualify for a Small Business Loan or Line of Credit?
Lenders review your business before deciding whether to approve a loan or line of credit. They consider factors like credit score, income, and required documents.
Credit Score:
- Business Line of Credit: Most lenders prefer a score of 600 or higher, though some may accept as low as 550.
- Term Loan: A score of 650 or more is needed to qualify for better interest rates.
Business Income:
- Line of Credit: Businesses earning around $50,000 per year usually qualify. Some lenders may approve newer businesses with lower revenue.
- Term Loan: Lenders prefer companies making at least $100,000 annually and operating for one to two years.
Required Documents:
- Line of Credit: Basic paperwork such as bank statements and tax returns.
- Term Loan: More detailed documents, including a business plan or collateral (assets to secure the loan).
New businesses may find it easier to qualify for a line of credit, while established businesses with steady revenue and good financial history have a better chance of getting a term loan with lower rates.
Pros and Cons of Business Lines of Credit and Term Loans
When choosing between a business line of credit and a term loan, it’s important to understand the benefits and drawbacks of each.
1. Business Line of Credit
Pros:
- You can take only the amount you need, so you don’t borrow more than necessary.
- Once you repay it, you can use it again without reapplying.
- Access to cash is quick, making it useful for unexpected expenses.
Cons:
- Interest rates can go up, making it more expensive over time.
- Extra fees, like annual and withdrawal charges, can add up.
- Since it’s easy to access, you might borrow too much without realizing it.
2. Term Loan
Pros:
- Fixed monthly payments make budgeting easier.
- If your business is strong, you can get lower interest rates.
- Best for big expenses like equipment or expansion.
Cons:
- Payments are required regularly, even if you don’t need the money at the moment.
- You receive the full loan amount at once, whether you need it all or not.
- Harder to qualify for, especially if your business is new or has low income.
By understanding these points, you can choose the best option for your business needs. If you need flexible funds, a business line of credit may work better. If you want structured payments for a larger expense, a term loan could be the right choice.
Real-Life Examples of How Small Businesses Use Lines of Credit and Term Loans
Understanding how a line of credit and a term loan work in real-life situations can help small business owners make better financial choices. Here are three examples:
Example 1: Gift Shop
A gift shop owner needs extra money during the holiday season to buy more products. She gets a $12,000 line of credit to stock up on gifts. After the holiday sales, she repays the money in January but keeps the credit open for future slow months. This way, she only borrows what she needs and pays interest for a short time.
Example 2: Painter
A painter wants to grow his business by buying a van for transportation. He takes a $20,000 term loan, making fixed payments of $400 per month for five years. The van helps him reach more clients, increasing his earnings. Since term loans have lower interest rates, he saves money in the long run.
Example 3: Food Truck
A food truck owner needs money for daily expenses like gas and food supplies. She uses a $5,000 line of credit to cover short-term costs. Later, she decides to upgrade her grill and takes a $15,000 term loan to buy a new one. The business line of credit helps her manage daily expenses, while the term loan supports long-term business growth.
These examples show that both funding options serve different purposes. Small business owners can use them wisely to handle both short-term needs and long-term investments.
Questions to Consider When Choosing a Loan for Your Business
Choosing between a business line of credit and a term loan depends on your business needs. Asking the right questions can help you decide.
Q. Why do you need money?
- If you need cash for small, changing expenses, a business line of credit is a better choice.
- If you’re making a big one-time purchase, like equipment, a term loan is the right fit.
Q. How fast can you pay?
- If you can repay quickly, a line of credit works well.
- If you need more time, a term loan lets you pay in fixed amounts over months or years.
Q. Can you handle interest rate changes?
- If rising interest rates don’t worry you, a line of credit is flexible.
- If you prefer a steady, predictable payment, a term loan is safer.
Q. Is your income steady?
- If your business has ups and downs, a business line of credit helps cover slow times.
- If you have a stable income, a term loan fits well.
Q. How old is your business?
- New businesses might find a business line of credit easier to get.
- Established businesses with good financial records can qualify for a term loan.
For example, a tailor who faces slow weeks may rely on a line of credit to manage expenses. Meanwhile, a carpenter with steady projects might prefer a term loan to buy tools or a work van. Picking the right option helps businesses grow without financial stress.
Where Can You Secure Business Loans?
- Banks: Give loans with low interest, but you need strong financial papers and good credit. Best for businesses that are already doing well. Getting approved takes time, but the loan terms are good.
- Online Lenders: Approve loans quickly with fewer rules, making them great for businesses that need money fast. But they charge higher interest and fees. Good for those who can’t get bank loans.
- SBA Loans: Supported by the government, they offer fair interest rates and longer time to pay. The process takes time and requires good credit. Best for businesses that can wait for funding.
- Credit Unions: Give fair loans with lower fees, but you must be a member. They offer a friendly and simple process. Good for small businesses looking for affordable loans.
How Small Biz Heroes Support Business Growth?
Small Biz Heroes was created to help small businesses get the funding they need, even during tough times. We offer over 20 business financing programs designed to fit different business needs.
Our mission is to find the best loan options for our clients based on their qualifications and how they plan to use the funds. We offer competitive financing solutions similar to those from Chase, Bank of America, and Wells Fargo.
If a business doesn’t qualify for a certain loan, we provide guidance to find the right funding option. Small Biz Heroes recommends checking at least three different sources to secure the best loan deal for your business.
Conclusion
Both a business line of credit and a term loan offer valuable financial support, but the right choice depends on your business needs. A line of credit is best for managing cash flow, covering unexpected expenses, or handling short-term needs. On the other hand, a term loan is ideal for large investments with predictable repayment plans. Understanding how each option works allows small business owners to make informed decisions, ensuring financial stability and long-term growth. If you need a business loan, you can contact Small Biz Heroes for the best financing solutions!