Loans vs Lines of Credit

Guest Post By Rebecca Kennedy

Is a Loan or Line of Credit Better for Business Financing?

When you are searching for the best-fit financing to grow or sustain operations in a business, the number of options can seem overwhelming. There are lenders who offer complex products based on the assets held by the business, crowdfunding platforms that engage everyday investors, and conventional banks that provide a variety of borrowing vehicles based on how the funding will be used over time. While the options are daunting, it helps to understand the differences between the two most common categories of business lending – a business loan and a line of credit.

What is a Business Line of Credit?

A business line of credit is most easily compared to a personal line of credit from a bank or credit union, such as a credit card, an overdraft credit line for a checking account, or a home equity line of credit on a home. For a business, a line of credit provides access to a set amount of financing determined by the lender, and businesses can tap into that credit line up to the maximum at any time. Interest does not accrue on a business line of credit and repayment is not required until a draw on the credit line is made. This offers a great deal of flexibility for business owners who do not have a firm number associated with their borrowing needs.

Business lines of credit are offered as either secured or unsecured lines. Secured lines of credit are attached to an asset, like equipment, accounts receivable, or inventory, while unsecured lines of credit are approved based on the credit history of the business or business owner. When collateral is involved, the interest rate and other fees associated with a line of credit are lower, making the credit line more affordable over time.

What is Business Loan?

Business loans are similar to personal loans in that a bank of other financial institution provides a single lump sum payment to a qualified business that is then repaid over time. Repayment terms for business loans range depending on the credit history of the business or business owner, the amount borrowed, and the reason for the loan, but most require payment in weekly or monthly installments over the course of one, three, five, or 10 years. The borrower pays the same amount over the life of the loan until the balance is paid off. Interest charges for business loans vary based on the repayment term, the amount borrowed, and the credit profile of the borrower.

Like credit lines, business loans can either be attached to collateral, like a title loan or an auto loan in personal lending, or offered as an unsecured loan. Banks that provide financing through loans that are secured are able to do so at a lower interest rate than what may be offered on an unsecured business loan. In most cases, business loan lenders require a personal guarantee that the loan will be repaid as agreed.

Which is Right for My Business?

Every business faces different needs for financing over time, but there are certain instances where a business line of credit makes more sense than a business loan or vice versa. Should a business have an ongoing need for access to affordable credit, either due to cyclical changes in revenue or providing working capital for short-term lulls in profitability, a business line of credit is a better option. When a business has a clear need to purchase inventory, equipment, or real estate for the improvement or expansion of operations over the long term, a business loan may be the most suitable choice. Business lines of credit may be appropriate for business owners who are concerned about borrowing too much for a financing need, or those who want more flexibility in repayment over time. For businesses that have a strong cash flow projection and steady revenues, a business loan is a smart choice given its potentially lower cost over the life the of the loan. Before selecting a business line of credit or a business loan, business owners should read the terms provided by the lender in full to ensure they are receiving affordable funding for business needs.

 

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