Lines of credit (LOCs) and small business term loans are both powerful tools for managing finances and growth, but they are very differently structured and serve distinct needs. The best option for you likely depends on how you plan to spend the money and when you need it: You may have big plans for growth that require a significant investment, or you may require occasional access to funds to meet ongoing business demands.
The following overview of LOCs and business term loans may help you determine what sort of funding is your best choice.
How they work
A business line of credit is an amount of money that you can access when cash demands arise — you draw out the funds when a need emerges and then repay the lender with interest. For example, if you have a $5,000 line of credit and withdraw $1,000, your credit limit will drop to $4,000. Once you repay that $1,000, the amount of credit available returns to $5,000.
A business term loan, on the other hand, gives you a lump sum, typically at a fixed interest rate, with regular repayments on a set schedule. This structure means you’ll always know exactly how much the payment will be and when it’s due. Loans are usually multi-year and require monthly payments.
Examples of how business term loans and lines of credit work in real life can help to paint a picture of how businesses rely on these tools. Use the following examples to help with your decision.
Lines of credit work best when you have periodic, short-term needs for an infusion of cash.
Business case #1:
Business case #2:
Business case #3:
The up-front sum of a term loan is useful when you want to make specific investments aimed at growing your business. Here are some cases to consider, using the same example businesses as above.
Business case #1:
Business case #2:
Business case #3:
When you draw on your line of credit, you will be charged interest on the amount you withdraw from the time you access the funds until the time you pay it back. Lines of credit typically have variable rates that fluctuate with the prime rate. That’s why LOCs may be most useful as a flexible tool for managing shorter-term cash needs.
With a term loan, you are committed to regular payments at a fixed interest rate. This predictability is helpful for business planning, but you are typically committing to regular payments for several years when you get a loan, so be sure the payment period makes sense for how you plan to use the money. For example, you typically wouldn’t want to take out a five-year loan to buy equipment that may only last for three years. It’s important to compare the full cost of the loan with the financial gain you expect from the investment.
While both financing instruments may have a place in your business toolbox, you’ll also want to ask prospective lenders about the specific terms available to you, including the total cost of the borrowing option you choose and how soon you can access the funds. Find out who will be your point of contact if you have questions or problems.
There are many reasons you may want to close a credit card. Maybe you want to simplify your personal…
Read MoreCreating a budget is easy—there are countless handouts, spreadsheets, and apps you can use to help you start saving…
Read MoreWhether due to a layoff, homeschooling children, or divorce, many people find themselves going from a dual-income to a…
Read More