The Difference Between Term Loans & Lines of Credit
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No matter what type of business you have, there often comes a time when you need extra funds. Maybe your building needs some renovations, or you need to replenish your inventory in a hurry. Maybe there’s some specific equipment that’s necessary for you to run smoothly.
Picking the ideal financial product for your needs, however, takes some consideration. Below, we’ll take a look at two of the more common ways to finance your business: term loans vs. lines of credit.
Table of Contents
What Is A Term Loan?
Term loans come in many different forms, but they all have a few things in common. Term loans usually deliver funding in a single lump sum, with repayment beginning immediately. A term loan is repaid over a specific period, usually between a few months and 10 years.
Short-term loans usually last less than a year and use a fixed fee structure. Repayment, as the name implies, is rapid, with payments made daily or weekly. Medium- and long-term loans usually accumulate interest over time and are repaid weekly or monthly. Typically, short-term loans are faster, with funding available within a business day or two, while long-term loans tend to be slower but have better rates. There are, of course, exceptions.
Term loans are ideal for established businesses that are attempting to expand, need to make a large purchase, or otherwise have a one-off expense of some kind.
What Is A Line Of Credit?
If you’ve ever used a credit card, you have an idea of how a line of credit works.
Instead of offering you a lump sum, as is the case with a term loan, your lender extends you a line of credit of x-number-of-dollars. Then, for the duration of your line of credit, you can draw upon that credit at will, accumulating debt up to a maximum equal to your credit limit. Most lines of credit are revolving, meaning that as you pay off your credit debt, it becomes available to use again.
Lines of credit are best for businesses looking to smooth out their cash flow or who want to have a reserve fund they can use to pay for unexpected expenses throughout the year. Lines of credit generally have higher interest rates than comparable term loans, but they’re far more versatile.
Lines of credit also come in many different forms, including:
- Unsecured Lines Of Credit: An unsecured line of credit is simply one that isn’t secured by an asset. Although there is no formal collateral per se, you may be asked to sign a personal guarantee.
- Asset-Backed Lines Of Credit: A line of credit that bases the amount of credit extended to you on an asset you provide as security. If the value of your asset changes, your credit limit may as well.
- Invoice-Backed Lines Of Credit: An asset-backed line of credit that uses your invoices as security. Not to be confused with invoice factoring.
- Home Equity Lines Of Credit (HELOC): A line of credit that uses the equity you’ve built up in your home as security. HELOCs often last around 10 years and feature interest-only payments during that period.
Loan VS Line Of Credit: Key Differences
So what are the key differences of a term loan vs. a line of credit?
Term Loans (Usually) Have Longer Repayment Periods
This doesn’t necessarily apply to short-term loans, but if you need a large chunk of money and a long time to pay it off, a term loan can spread the pain over a more extended period.
Term Loans Are (Usually) Easier To Get
With the alternative lending market deemphasizing credit scores in their underwriting process, it’s not too hard to get a loan these days so long as you have a fiscally healthy business. Lines of credit aren’t necessarily difficult to get, but lenders are often a little more conservative when it comes to extending credit.
Term Loans (Usually) Have Better Rates
In most cases, you’ll pay a premium for the convenience a line of credit offers, whether in interest rates or fees.
Lines Of Credit Are Much More Convenient
Having a big chunk of money you can draw on whenever you need to can take a load off your mind and make day-to-day expenses easier to navigate.
Lines Of Credit Mean You Don’t Have To Reapply For More Funding
Did you apply for a term loan and then find out you need more money a month later? Have fun going through the process all over again and possibly running the risk of stacking loans. Or you could just draw on your line of credit.
Lines Of Credit Sometimes Have Additional Perks
Some lenders will issue cards that allow you to use your line of credit like a credit card. Some even have rewards programs similar to those of credit cards.
Which Is Right For Your Business?
If you’ve made it this far, you’re probably getting a sense of whether a term loan or line of credit is better for your business needs. Just in case, let’s hammer the points home.
You might want a term loan if:
- You know exactly how much money you need for a particular expense
- You don’t already have access to credit and need money quickly
- You need a large lump sum of money
- You need a lot of time to pay off your loan
You might want a line of credit if:
- You foresee having a lot of smaller expenses over a more extended period
- You want access to cash when you need it
- You want to have a financial cushion to fall back on if unexpected expenses arise
- You want a reusable source of funding
Final Thoughts
Whether a term loan or a line of credit is best for your business depends a lot on the types and quantities of expenses you are attempting to take on. If you need a lump sum, are able to state the intended use, and can pay the money back over the next few years, a term loan might be for you. If your financial needs are vaguer and your ability to repay quickly is more solid, a line of credit may be the way to go.
Think you need a loan? We can help you find a lender that works for you. Is a line of credit more your style? We can help you find a line of credit as well. Are you feeling confused or intimidated? We can also help you navigate the application process.
Chris Motola
Finance Writer at Merchant Maverick
Chris Motola is a writer, programmer, game designer, and product of NY. These days he's mostly writing about financial products, but in a past life he wrote about health care and business. He's a graduate of the University of Central Florida.
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