Comparing a business line of credit vs. loan is like comparing apples and oranges. They both give your business cash to accomplish a goal and come with their own lists of benefits. However, their structure and role in driving your business growth make them more different than they are similar.
If you’re debating between a line of credit vs. a loan, there’s no clear answer as to which is better for your small business.
Understanding the differences and similarities between a business line of credit vs. loan options can help you determine which solution is best for your needs. Here’s what you need to know.
Business Lines of Credit vs. Business Loans
Essentially, small business loans are lump-sum financing products. They’re typically used to finance large, one-off purchases or investments. A business line of credit, on the other hand, gives you more flexibility, especially when it comes to managing unexpected expenses or meeting ongoing needs.
Here are some of the key differences between a business line of credit vs. loan.
- Some business loans typically feature higher interest rates, though this depends on a number of factors
- Business loans come with fixed payment terms, while a business line of credit is more flexible.
- Business loans normally feature larger funding amounts than lines of credit
- Most business loans are intended for specific purposes, while a business line of credit can be used to cover a larger variety of business expenses
What Is a Business Loan?
A business loan is a lump sum of capital offered by lenders. Small business loans require you to pay back your principal plus interest over a set period of time, which is determined in the initial agreement.
You will be given a set amount of cash, which you must repay within a set timeframe. Business loan payments usually follow a predetermined schedule, ranging from daily to monthly. You’ll most likely have to start making repayments immediately after receiving financing.
Depending on the lender and your specific qualifications, you may also be asked to put up collateral in order to secure your business loan.
Business loans are best for financing specific, one-time projects. You can use a business loan to expand operations, open up new locations, purchase equipment, buy real estate, or pursue other growth opportunities. In other words, most small business owners seek loans when financing large, planned expenses rather than in one-off transactions.
In some cases, your lender may ask how you’re planning to use the loan before approving your application. If you’re applying through a traditional lender like a bank, be sure to prepare a detailed business plan.
What Is a Business Line of Credit?
A business line of credit allows you to borrow money up until a set amount or your credit limit. In this way, a business line of credit works similarly to a credit card. When you apply, lenders will grant you a set credit limit, which you can draw upon as needed.
You’ll only have to pay interest on the amount of money you use.
Many small business lines are revolving. As you repay the balance, your credit limit will be replenished. This means you can continue to draw from it up until your new credit limit without reapplying or receiving approval.
A small business line of credit can be secured or, in other words, backed up by collateral. It’s also possible to obtain an unsecured line of credit.
You can use your small business line to cover ongoing expenses like payroll, seasonal disruptions, unanticipated charges, and even finance new opportunities. Many small business owners will also keep a line of credit as an emergency fund or safety net.
Key Differences Between a Business Line of Credit Vs. Business Loan
Small business loans and lines both allow you to borrow a certain amount of money and pay it back within a set timeframe. They’re both great tools to grow your business, as you need more working capital. However, this is largely where the similarities end.
There are several major differences between a business line of credit vs. loan. Understanding these factors will help you decide which financing solution is best for your business.
|Criteria||Business Line of Credit||Business Loan|
|Repayment Schedule||A business line of credit doesn’t come with defined terms and is much less rigid. You only need to make payments after drawing the funds||A small business loan locks you into a fixed payment schedule for a set amount of time – and you’ll have to start making payments immediately|
|APR & Fees||Depend on the lender and your business financials||Depend on the lender and your business financials|
|Requirements||More relaxed, but will depend on your desired funding amount||Stricter, but will depend on your desired funding amount|
|Uses||Nearly any business expense||Nearly any business expense, but you may have to provide your lender with a detailed plan of how you intend to use the funds to reach an approval|
|Reapplying||Have to reapply for additional funds||If revolving, your funds become available again after you’ve repaid them|
Business Line of Credit vs. Business Loan: Approval Process
The approval process for business credit lines and business loans is very similar. You find a lender offering what you need, apply, and wait to receive a decision. The speed of the process, however, depends on a few factors.
- The amount you’re seeking
- The type of lender you’re working with
- The speed at which you provide your business documentation
- If you’ve worked with the same lender previously
Banks and credit unions will return a decision in 30 to 90 days, whereas a non-bank lender can return a decision within 24 hours. Their speed is offset by higher interest rates, but many entrepreneurs find the streamlined process worth the added interest, especially if their opportunity more than covers the cost of capital.
Keep in mind that an approval is merely an idea until you finalize a contract. You should ask questions, negotiate terms if needed, and – if the offer doesn’t make sense for your business – walk away entirely.
Business Line of Credit vs. Business Loan: How to Apply?
Once you’ve decided which option you’ll take, you’ll begin to apply with lenders. Here are the main steps you should take.
- Evaluate Your Business Financials – First and foremost, you’ll need to understand the financial side of your business from both a macro and micro perspective. You should take careful note of your daily, weekly, monthly, and annual expenses, as well as forecast 6, 12, and 18 months into the future to account for potential slowdowns. The forecast doesn’t have to be 100% accurate; Just an informed idea of what you expect to happen within the time frame.
- Research Lenders – Your next step is to research lenders offering the product of your choice. You should review their qualifications, explore their reputation, and see if they could be a good fit for your business. As you go through your search, try to identify 5-10 top choices, so you can apply with only the best options for your business.
- Prepare Your Documentation – If you want to move as fast as possible through the process, it helps to come prepared with the relevant documentation. The specific documents you’ll need will depend on the lender you’re working with but expect to provide enough information for the lender to gain a better understanding of your business as a whole (Business bank statements, tax returns, proof of ownership, etc.)
- Fill Out Applications – Next, you’ll physically fill out application forms at the lenders of your choice. It’s of the utmost importance that you ensure the accuracy of each application you send, as any errors can return a falsely denied application, which prolongs the process and makes it challenging to select the best offer you qualify for.
- Wait for Decisions – Once you’ve applied, all you have to do is wait for each lender to respond to your applications. As decisions come in, you should review each one – even the denials – to learn what terms you’re approved for or if there were any hurdles to approving your business. This way, you can learn what lenders are looking for and move through the process more efficiently next time.
Business Line of Credit vs Business Loan: Which Loan Option Should You Take?
Well, which is better for your business?
Deciding between a business line of credit vs. loan essentially comes down to a few key factors. Before choosing, you’ll want to consider the amount of money you need, flexibility, and how you plan to use the funds.
A small business loan is best for financing one-off, specific expenses. Some examples include buying inventory, expanding, or pursuing new growth opportunities.
If you prefer to have a fixed monthly payment on a predetermined schedule, a business loan would be a good choice. Because the payback amount is fixed, you’ll be able to budget out your future expenses with greater accuracy than you would with a business line of credit.
If you’re looking to secure more funds or finance a long-term project, a business loan may be your best choice.
On the other hand, if you need extra cash to cover sudden costs like hiring, marketing, or covering operating expenses during seasonal lulls, then a business line of credit might be the best choice for you.
A business line of credit may also be the better long-term choice. You can draw funds up until your credit limit to cover cash flow disruptions or even emergencies. You also won’t have to make payments until you borrow the money.
How to Find the Right Financing Option
Between a business line of credit vs. loan, both are sound financing solutions that best serve business owners in different situations. Ultimately, the answer depends on your specific business model and goals for growth. Here are a few questions to get in the right headspace.
- Do I need flexibility?
- How much money do I need?
- Can my business meet elevated eligibility requirements?
- Can I offer collateral?
- How long have I been in business?
Finding the perfect financing option for your business can be a long and laborious process. To save yourself time and get expert financial advice on how to move forward, apply for financing through National.
After applying, a knowledgeable Business Financing Advisor will explain your options to help you choose the right one for you.
Frequently Asked Questions
Do I Need Collateral for a Business Line of Credit or a Business Loan?
The short answer – it depends. Collateral provides lenders with an extra layer of protection against financial loss, which makes them more likely to approve your application and offer favorable terms. If you’re having trouble reaching an approval that fits your business, it’s worthwhile to consider collateralizing a business asset.
Some financing programs come with collateral requirements, while others do not. For example, equipment loans often require collateral, but the asset the borrower purchases can cover the requirement.
It all depends on what you qualify for. Some businesses may not need to offer collateral because their financial background exceeds the minimum requirements and, more importantly, shows the lender they don’t pose a risk of default. Others may not be able to meet rigorous eligibility criteria, so offering collateral essentially levels the playing field, allowing entrepreneurs to grow and solidify a place in their industry.
Which Option Provides More Flexibility for My Business’s Financial Needs?
Business lines of credit. They offer the ability to draw funds on an as-needed basis, which is the opposite of business loans that provide a lump sum to manage over a set schedule.
Think of it this way: If you secure a business loan and need additional funds at any point, you’ll have to go through the application process again and take out another loan entirely. On the other hand, lines of credit provide consistent access to capital, and borrowers only pay interest on the amount they draw.
Can I Use a Business Line of Credit or a Business Loan to Start a New Business?
Yes, but it might be difficult. Many lenders prefer to work with businesses that have 1+ year of history, as startups are statistically more likely to fail than well-established businesses. This makes it more difficult to reach an approval, and even if you can, you’ll likely receive higher rates and less favorable terms, so it might not be worthwhile.
As an alternative, consider using business credit cards, personal investments, or crowdfunding to get your startup off the ground.
Can I Get a Business Line of Credit or a Business Loan With Bad Credit?
Yes! Some lenders offer bad credit business loans and lines of credit, but you should be aware that they may come with higher interest rates, lower funding amounts, or fees.
Offering collateral is a great way to meet lenders in the middle. You have a better chance of securing the terms you’re looking for, and the lender has a diminished risk of financial loss.