Business Loan vs. Line of Credit: The Difference

As you grow your business, applying for financing can boost your working capital to achieve your goals, whether you want to smooth out cash flow, prepare for financial emergencies, or  expand your operations. There are two primary types of small business funding to consider, each of which comes with its own set of pros and cons. Understanding a line of credit vs. business loan is a great first step in making a smart decision for your business based on your individual needs and goals. 

Business Line of Credit: How Does It Work 

A line of credit provides small businesses with flexible financing on your own schedule. Rather than getting a lump sum as you would with a business loan, you instead get access to a line of credit up to a certain dollar amount. You can draw on the credit line whenever you need capital, and only pay interest on your outstanding balance. 

This type of revolving credit is similar to the way a credit card works. When you pay back part or all of your outstanding balance, you can then borrow from that amount again when you need to. It’s easy to get a sense of how much a certain balance would cost using a business line of credit calculator.

Business Line of Credit: Terms and Rates 

A business line of credit can range anywhere between $1,000 and $500,000. Rates range from as low as 8% APR to as high as 24% APY. If you open a business line of credit with bad credit, you’re more likely to pay a higher rate. Funding times are quick, usually providing the cash you need within one to two weeks. The maturity term typically lasts between one and two years. 

It’s rare to find a business line of credit with no credit check, but you may be able to qualify with a personal credit score instead of one for your business. Similarly, you may not be able to get a business line of credit with no revenue at all, but you could qualify after being in business for a minimum period of time—often six months. 

Business Line of Credit: Requirements

Most lenders have specific requirements in terms of credit score, time in business, and revenue. Lendio’s network of partners typically request the following eligibility minimums:

• Personal credit score of 560+
• 6 months in business
• $50,000+ in annual revenue

A secured line of credit requires some type of collateral to back the financing. You’ll typically receive better terms, like a lower interest rate. Alternatively, you can also opt to apply for an unsecured line of credit, which doesn’t involve any collateral at all. 

Business Loan: How Does It Work?

Another type of financing is a small business loan, which is structured very differently from a business line of credit. You’ll get a one-time lump sum of cash to use however you want for your business. Then you’ll have fixed monthly payments over a set period of time, which include both principal and interest payments.  

Repaying a business loan is similar to repaying any type of installment loan, like a car payment or a mortgage. As long as your interest rate is fixed, so is your monthly payment. It gives business owners the ability to plan their finances because the payments don’t change. 

Business Loan: Terms and Rates 

Business loans typically range from $5,000 to $2 million. The larger amounts of money are reserved for stable businesses with a strong track record and enough revenue to handle the payments. The repayment period can also vary, usually between 1 and 5 years. Rates start as low as 6% APR and funding time is fast—online lenders can deposit cash within 24 hours. 

Business Loan: Requirements 

Business loans often require a review of both the company’s financials and the owner’s personal finances. As part of your application, lenders will review:

• Your credit history
• Time in business
• Collateral 
• Revenue

Just like a line of credit, a business loan can either be secured or unsecured, depending on whether or not you pledge any assets as collateral.

Business Loan vs. Line of Credit: The Difference 

There are benefits of a business line of credit as well as a business loan. Both help you build your business credit score, as long as the lender reports payments to the credit bureaus.  

With a business line of credit, you can borrow as much as you need over a set period of time thanks to a flexible credit line. Plus, the line of credit is replenishable, so you get ongoing access to capital. 

With a business loan, you receive one lump sum of capital. You would have to apply for another loan in order to qualify for additional funds. On the plus side, loans come with a fixed monthly payment so you can easily budget to pay off the balance.

Business Loan vs. Line of Credit: Which One Works Best for You?

There are a few different factors to help you determine which option is best for your business: a loan or line of credit. 

Amount needed: Term loans typically offer higher funding amounts than lines of credit. If you need to purchase a major asset, like a piece of equipment or real estate, then a loan is probably better than a line of credit. But if you don’t need a huge loan amount and have several purchases to make over an extended period, then a line of credit may be better. 

Timeline: Because loans often include larger amounts, they also have longer repayment periods. A line of credit, on the other hand, usually needs to be repaid in a year or two. 

Predictability: If you’re looking for a predictable payment plan, then a business loan is the way to go. But if you have consistent cash flow and don’t mind paying relative to the amount you borrow, then a line of credit could be a good choice.