8 Differences Between a Business Loan & Line of Credit
Note: This is a guest post by Tom Gazaway, founder and President of Hawkeye Management, a critical partner of Lendio that specializes in unsecured business credit lines for small business owners. We’re excited to have him on the blog. More of Tom’s bio is below.When you need some money to start, build, or grow your business, you’ll want to know the differences between business loans and business lines of credit.
Each serves a unique purpose that could propel your business forward. Knowing the differences will help you make the best decision about what is best for you and your company at the moment you need capital.
Here are 8 ways in which loans are different from lines of credit.
Business Loan vs. Business Line of Credit
1. Business loans are used one time whereas lines of credit can be used multiple times.
2. “When” you get a loan is different from “when” you get a line of credit. A loan is normally not something you would get until you need it because it’s normally for one specific purpose. A line of credit is something you obtain before you need it. Remember the line of credit, unlike a loan, is not for one specific purpose.
3. With a loan you have a monthly payment that, although there are a few exceptions, doesn’t change from month to month and those monthly payments begin right away. Whether you’re using all the money or not your monthly payment does not change. With a line of credit you only make payments on the amount of money you’ve borrowed so if your balance is zero your payment is zero.
4. The closing costs are higher for a loan than a line of credit. There are always exceptions to every rule but most loans carry closing costs anywhere from 2-7% whereas lines of credit have very minimal or no closing costs.
5. Loans carry with them fixed terms or amortization periods. Because of this the monthly payments on loans are usually higher than the monthly payments on lines of credit. Think about it like this. If you were to get a loan for $50,000 your monthly payment will likely be $400-700/month more than it would be if you owed $50,000 on a line or lines of credit.
6. Loans are usually best for long-term debt that gets paid off over 2 to 6 years. Lines of credit, however, are best for short-term purposes such as financing receivables, marketing, and making payroll. We acknowledge that lines of credit are great for unexpected cash-flow issues but make sure you don’t exhaust your lines of credit on surprises. Use as much of your line of credit for what we call RGA – Revenue Generating Activities. If you use some of your funds for a marketing initiative (or several of them) then you’ll likely be able to justify the new debt you’ve incurred because you’ve also generated additional revenue and grown your organization.
7. Business loans have higher interest rates but they are normally fixed rates. Business lines of credit normally have lower interest rates but are variable. This simply means that if you manage your lines of credit poorly by making late payments or going over the credit line then — from an interest rate perspective — you would have been better off getting a loan. Whereas with a line of credit the rate can actually get better with good credit management.
8. Loans are usually somewhat interest-rate driven, whereas lines of credit are not as rate-sensitive. With a line of credit, that is used primarily for short-term purposes, it’s more important to have a monthly payment that is “cash-flow friendly” and, even though the rates are normally quite good, it’s more important that the line can be used repeatedly and the monthly payment is as low as possible in relation to the balance.
The various products, lenders, guidelines, and constantly changing standards have made the credit and lending landscape for small businesses a rather delicate, perilous, and formidable one.
If any of this seems overwhelming, if you have ever needed some funding and been denied by a bank, or didn’t get all the funding you needed, then join the club. Banks are approving less than 10% of the applications they get from small business owners, so look to companies like Lendio for the expertise to solve your credit and lending needs.
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About the Author
Tom is known as the “credit geek” for his knowledge and insightful understanding of FICO® scores and the FICO® credit scoring system. He’s a frequent guest with a variety of groups throughout the country on the topics of credit, unsecured lending solutions, business capital, debt capital solutions, and business lines of credit.