Term Loan vs Line of Credit – What’s Best For your Business
There are various finance options available for different use and purpose. Choosing one over the other depends on why you need the funds. Here in this article, we are going to compare term loans vs lines of credit where we’ll know the uses, lending amounts, terms and pros, and cons and help you know what’s best for your business.
Term loan vs line of credit: What it is?
A term loan helps borrowers to receive a lump sum of cash upfront on specific borrowing & repayment terms. Repayment terms cover the payment schedule, interest rate, and term or length of the loan. If you are an established small business, you can consider having term loans.
On the other hand, a line of credit offers a pool of funds with a pre-approved borrowing limit that you can draw without justifying the specific purpose of use. You only have to repay the funds you use with the interest. The best use of lines of credit is for ongoing operating expenses or when the emergency fund is required.
While term loans and lines of credit both are good financing options for businesses, still it’s important to consider your business needs and goals when choosing either of them. Both of these loans work differently and serve different business needs.
Business Term loan vs Lines of credit – Key Takeaways
Some key points to know about Term Loans:
- Banks, credit unions, CDFIs, and other lenders will set your loan terms.
- For a business-term loan, you can borrow up to $5 million
- Having a responsible lender by your side, you will get the funds you need with terms that you can pay back on time and in full.
- The repayment period of most term loans will be 5 to 10 years with competitive interest rates.
Some key points to know about Lines of Credit:
- Lines of credit are usually issued by banks and credit unions.
- A business line of credit can be used to meet your business’s financial needs, as long as the maximum monthly payment is met.
- For a business line of credit loan, you can borrow up to $250k
- The higher maximum amount limit with a business line of credit is what makes it different than the credit limit.
- A line of credit comes with lower interest rates than credit cards
- A line of credit allows you to use only what you need up to the maximum limit, and make the repayment over time. Small business lines of credit are often set up to allow you to make interest-only payments for a set amount of time.
- The monthly payment you are required to make can vary based on how much of the credit line you’ve used when the interest rate is variable. The advantage is that you don’t need to pay for the money that you’ve borrowed and haven’t spent.
Terms Loans are Best for Business owners with
- Ability to make predictions for exact repayment schedules over a long period of time.
- Owned assets to borrow against
- Low or no credit score
- Business with less or no presence for a very long time
- Large amount of capital needs
Line of Credit is Best for business owners with
- Established a relationship with your business banker
- Need for variable amounts of money at intermittent times.
- Ability to make repayment a line of credit in a short period of time
- Need for quick access to money to capitalize on the business opportunity
- Valuable asset that they can borrow against
- Less amount of capital needs
Term Loan: Pros and Cons
There are several benefits of term loans that it brings to the table for borrowers along with certain drawbacks that also need to be considered.
- The loans often have lower interest rates than the line of credits
- You can lend larger loan amounts than a line of credit. Term loan amounts are tied to the value of the purchasing asset, not the value of already owned assets.
- Term loans make it possible to acquire fund without the need for good credit, assets you already own, or a well-established relationship with a business banker.
- A pre-determined repayment amount and period of payment.
- Needs proper justification of what you are buying with the loan funds and shows how it will help your business.
- You need to pay a down payment if you are planning to use the loan for purchasing equipment or another large asset.
- It comes with a long-term contract that needs to be followed to make regular loan payments for the entire term of the loan, which could go from years to decades.
- The loan comprises a long approval time. For the application submission, it can take around days or weeks before your financial institution releases the final decision on the application. This makes it challenging to use a term loan to take advantage of certain business opportunities, like the sale of equipment, or to cover urgent needs, like a payroll shortfall.
- The money can only be used for the specific purpose that was approved in the loan. If the reason for the loan is to buy a new oven for your bakery, then the loan funds can only be used to buy that oven.
Line of Credit: Pros and Cons
- Line of credit lends you money when you need it once it is established. You can capitalize on your business opportunity without waiting for your application to be processed.
- A line of credit helps you run the cash flow cycle smoothly. Every business operates differently, therefore, comes with different financial needs. For a seasonal business that could experience highs and lows into the business, a line of credit can help continue operating the business during these times.
- Line of credit allows for creating a good relationship with your business banker which can be beneficial in the long run to grow your business.
- Interest rates are higher than what you can usually get on a term loan from a bank.
- Line of credit has variable interest rates and can vary from month to month or week to week.
- There is no fixed amount of time to make the repayment of the principal of the loan. While lines of credit don’t have a fixed repayment term for the principal of the borrowed amount, you need to pay interest every month you have borrowed. This is good because you can use the money for as long as you need it but it can also be bad because you might pay higher interest rates on a large sum of money until the borrowed money is been paid completely.
- You often must pay a fee every year for your line of credit, even if you don’t use it.
- The limit of your line of credit is based on the assets that you own. Your credit limit is tied to the value of those assets, so you cannot sell those assets and still maintain the line of credit.
Best Lender to Borrow Term loan or Line of Credit for Business
Gconnectpro financial services have become the primary choice for hundreds of businesses to borrow small business term loans and lines of credit to provide adequate funds and fulfill finance needs. You can connect & choose from 100+ lenders to help you lend the money you need.
So, what are looking for? With GConnectPro, rest assured that you’ll get the best loan at the most suitable terms for yourself and your business.
FAQs – Term Loan vs Line of Credit
When to use a line of credit?
A business line of credit is called an operating line of credit because of its purpose to help finance ongoing operating expenses. Business lines of credit are best for short-term financing needs as well as ongoing operating expenses, such as payroll, seasonal expenses, unexpected payments, or temporary cash flow shortages.
Which loan type has a better repayment structure?
While term loans have a set, predictable repayment structure where you make payments of equal size at equal time increments, lines of credit repayment structure are much more fluid. Since you only have to repay what you use, you may have your line of credit for months before you start making payments. As such, lines of credit don’t have such defined terms.