Which Is Best For You? – Forbes Advisor

Choosing between a business line of credit and a business loan can be challenging. Ultimately, the best financing option for your business depends on several factors. While lines of credit can address cash flow needs over time, loans offer a lump sum that can be used for major purchases, expansion and other significant expenses.

Consider the amount of money you need to borrow, the purpose of the loan and how quickly you need the funds before deciding between a business loan and a business line of credit.

What Is a Business Loan?

A business loan is a lump sum of money a business owner borrows and then pays back over time with interest. Loan amounts often extend up to $500,000, but amounts up to $5 million may be available from some lenders. Repayment terms can be short term or long term and may range from a few months to 25 years, depending on the lender.

Borrowers can use business loans for a variety of purposes, such as expanding their business, purchasing inventory or equipment, or covering operating expenses. However, many lenders require borrowers to indicate the loan purpose during the application process. Even so, the flexibility of small business loans makes them a good option for business owners who need to access a large amount of cash quickly and want to repay it in fixed installments over time.

Related: Best Small Business Loans

How Do Business Loans Work?

Business loans are available from numerous lenders, including traditional banks and credit unions. This type of financing may also be available through online lenders—often with more streamlined applications and faster processing speeds.

Once a business owner applies for and is approved for a loan, the lender disburses the funds to the borrower’s bank account as a lump sum. Interest immediately begins to accrue on the entire loan amount, and payments are due each month. Annual percentage rates (APRs) typically range from around 4% to 7% for traditional banks or 11% to 44% for online lenders. Some lenders also charge origination fees that can range from 3% to 5% of the loan amount.

What Is a Business Line of Credit?

A business line of credit is a kind of revolving credit that a business owner can repeatedly borrow from and pay off—up to a certain limit and as needed. This type of financing is similar to a credit card in that you’ll only pay interest on the amount of money you actually borrow rather than the entire line of credit.

Credit limits for business lines of credit, typically range from $2,000 to $250,000, depending on the lender.

Related: Best Business Lines of Credit

How Do Business Lines of Credit Work?

As with term loans, business owners can apply for lines of credit through traditional and online lenders. Qualification criteria and the application process are often less rigorous than those required by traditional business loans.

Remember that if you’re approved, you’ll only be charged interest on the outstanding balance, not the entire credit limit. Borrowers can access funds repeatedly during the draw period—often up to five years. That said, APRs are often higher than those available for business loans and fall between 10% and 99%, depending on the borrower’s creditworthiness.

Pros and Cons of Business Loans and Lines of Credit

There are several benefits and disadvantages to consider when deciding whether a business loan or line of credit is right for your company. Familiarize yourself with the pros and cons of each before applying for financing.

Pros of Business Loans

• Funds can be used for almost any purpose, though it must often be specified in the application.
• Interest rates are usually lower than those on business lines of credit.
• Fixed rates and equal monthly payments make it easier to budget.
• Repayment terms often extend up to 25 years, resulting in lower monthly payments.

Cons of Business Loans

• May require collateral, such as property or equipment, to secure the loan.
• Repayment schedules can be inflexible, and missed or late payments can result in additional fees.
• A personal guarantee may be necessary, meaning the borrower is responsible for repaying it even if the business cannot.

Pros of Business Lines of Credit

• Borrowers can use funds for most business purposes and don’t need to disclose the use case in the application.
• Business owners can access funds based on cash flow needs.
• Interest rates are typically lower than for a credit card.
• Borrowers only pay interest on the portion of the line of credit that is in use.

Cons of Business Lines of Credit

• Interest rates are higher than for business loans and may extend up to 99%.
• The application process can still be time consuming.
• Lines of credit may lead to overspending or a cycle of borrowing.
• Borrowing limits are lower than for business loans.

How to Choose Which Option Is Best for You

If you are unsure which type of loan or line of credit is right for your business, you may want to speak with a financial advisor or accountant to get expert advice. Still, there are a few things you can consider when choosing the right business loan or line of credit for your needs, including:

• Borrowing needs. A business loan may be the better option if you need a lump sum of money for a one-time purchase, such as equipment or property. A line of credit may be a good choice if you want ongoing access to financing. Also pay attention to how long each option and lender will take from application to funding.
• Use of funds. If you need the funds for a specific purpose, such as to purchase inventory, a business loan may be the better option. If you need cash for multiple or ongoing purposes, a line of credit may be a better choice.
• Available APRs. Interest rates for business loans and lines of credit vary depending on the lender, your creditworthiness and other factors. However, rates are usually lower for business loans than for lines of credit.
• Repayment terms. Consider how much time you will need to repay the loan or line of credit and whether you can afford the monthly payments. Business loan terms may extend up to 25 years while lines of credit come with shorter terms.
• Collateral and personal guarantees. Business loans and lines of credit might require collateral and may require a personal guarantee. This means you could be held liable for repaying the loan if your business cannot. Make sure you are comfortable with this risk before taking out a loan or line of credit.

Business Line of Credit vs. Business Loans

Where to Get Business Loans and Lines of Credit

Business loans and lines of credit are available from a variety of sources, including traditional banks, credit unions and online lenders. Depending on your needs and qualifications, you may also consider borrowing funds from friends or family.

Interest rates and loan amounts vary by lender, so compare rates at local banks and credit unions as well as online lenders to see what terms you’re likely to qualify for. Regardless of where you take out a business loan or line of credit, read the fine print carefully before signing any documents.