Two of the most common types of small business financing are the term loan and the business line of credit. They can both put money in your business, but they work differently and suit different needs.
How a term loan works
A term loan gives you a lump sum up front. You repay it, plus interest, on a fixed schedule over a set term. Because the amount and schedule are known, the payment is usually predictable. Term loans are often used for one-time investments with a clear cost, such as equipment, a renovation or an expansion.
How a business line of credit works
A line of credit gives you a credit limit you can draw from as needed. You typically pay interest only on the amount you've drawn, and as you repay, that credit becomes available again. Lines of credit are often used for recurring or unpredictable needs — covering cash-flow gaps, buying inventory ahead of a busy season, or handling unexpected costs. Some lines have a draw period and must be renewed, and the lender may review the line periodically.
Side by side
- How you get funds: a term loan pays a lump sum; a line of credit lets you draw over time.
- What you pay interest on: the full loan balance for a term loan; the drawn balance for a line of credit.
- Payment pattern: a term loan usually has a fixed schedule; a line of credit's payment changes with what you've drawn, and many lines carry variable rates.
- Fees: term loans may carry an origination fee; lines of credit may have draw, maintenance or annual fees.
Questions to ask before you choose
- Is the need a one-time cost or ongoing?
- How predictable is your cash flow, and how often would payments be due — monthly, weekly or daily?
- Is the rate fixed or variable, and what's the APR once fees are included?
- Is collateral or a personal guarantee required?
Lenders review things like time in business, revenue and credit for both products; see how to prepare to qualify for a small business loan for steps to get ready.
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