What is the difference between a line of credit and a business loan?

October 28, 2015 / Reading: 3 minutes



Finding the right type of financing is crucial for the growth of your small business. Business lines of credit and small business loans are the most common types of financing options available to smaller companies.

However, before you decide on pursuing either of these financing options, it is important to understand the key differences, advantages, and disadvantages of small business loans vs line of credit.

Business Lines of Credit in General

Business lines of credit are similar to personal lines of credit, like home equity lines of credit and revolving credit card lines. Essentially, you will have access to a specified amount of credit. These lines of credit can be secured or unsecured. If they are secured, they are often secured by your accounts receivables or inventory.

With lines of credit, you can use them over and over without penalty. However, lines of credit are typically renewed every few years, so interest rates and exact credit amounts can fluctuate with the economy, your company’s credit, and your business’s amount of collateral, if needed.

Business Loans in General



If your small business decides to take out a term business loan, you will borrow a fixed lump sum of money, receive the entire borrowed amount once, and will pay back the loan over a specified period of time. The specific time period, or “term,” typically ranges from one to twenty years and are fixed for a specified amortization period. Like lines of credit, term loans can be either secured or unsecured, but lenders tend to prefer secured term loans to advert risk.

Payments

Monthly payments different significantly between lines of credit and small business loans. With a business loan, your monthly payment typically begins a month after you take out the loan. Additionally, monthly payments for these loans tend to be fixed and do not change month to month. However, if you take out a line of credit for your small business, monthly payments are contingent upon the amount of money you have borrowed. Simply put, if you carry a zero balance on your line of credit, you will not have to make a payment.

Closing Costs

Closing costs are typically higher for a loan than a line of credit. While exceptions exist, on average, the closing costs for a majority of loans tend to range between 2% and 7%. Loan closing costs include the cost of processing, appraisal fees, and credit. However, lines of credit tend to have lower closing costs, and often do not have any costs associated with closing. For lines of credit that do include minimal closing costs, these costs include the cost of transactions, processing, and withdrawal fees.

Interest Rates

While both lines of credit and business loans are subject to interest rates, lines of credit tend to be lower. Lines of credit typically have low variable interest rates that tend to remain low if you manage your line of credit wisely. However, if you pay late or exceed your line of credit, your interest rates will likely increase. With business loans, interest rates can be fixed or variable, but in general, they tend to be higher fixed rates with no means of negotiation after agreeing to the loan.