Business Loan vs. Line Of Credit: Which Is Better For Your Small Business

Small businesses are the backbone of the U.S. economy. According to the Chamber of Commerce:

  • Women own 45% of all small businesses
  • Over 90% of all businesses are small businesses
  • Close to 50% of the nation's workforce (about 120 million Americans) are employed by small businesses
  • Small businesses create around 2 million new jobs every year
  • In 2021, there were 33.2 million small businesses in the U.S.

While these statistics remain impressive, running a small business isn't for the faint-hearted -- even when balanced by the many rewards of this process. There are tons of things to do and tough decisions to make. If challenging times arrive, you might need a cash infusion.

When small businesses need more funds, they generally have two choices: a business loan or a line of credit. Choosing between the two can be the difference between growing your business fast and slowing it down. We want to help you grow quickly. In this guide, we take a closer look at both types of financing, their differences, pros, and cons to help you make an informed decision.

Related Reading: A Business Owner's Guide to Business Loans

What is a Business Loan?

Business loans or term loans offer small business owners a lump sum of money to repay over time (with interest, of course). Depending on the purpose, business loans can either be long-term or short-term.

Long-term loans are meant to finance long-term goals like remodeling or buying a building. They are usually more significant amounts with 3 years or more repayment period.

On the other hand, short-term loans are designed to help small business owners with immediate needs like paying employees, paying rent during a slow season, or buying inventory. These loan types generally have a shorter repayment period of about six months. 

Pros Of Small Business Loans

  • You will receive one lump sum amount
  • Predictable repayment amounts make it easier to budget
  • Based on your business qualifications, you may get a low-interest rate

Cons Of Small Business Loans

  • You may not get the entire amount needed
  • Additional funds require a new application
  • Some lenders charge loads of extra fees
  • You may have to provide collateral or a personal guarantee

What is a Line of Credit?

A business line of credit is similar to a credit card. It allows you to borrow up to a specific limit, and you only pay interest on what you've borrowed. Once you repay, you can continue drawing on the funds again.

Pros Of Business Line Of Credit

  • Easy to access funds after getting approved
  • Only pay interest on what you borrow
  • You can borrow many times
  • It may provide higher loan limits and more favorable interest rates than credit cards

Cons Of Business Line Of Credit

  • Interest rates may be variable for all balances, making it difficult to budget
  • Some lenders may charge annual or monthly fees
  • It may need regular review to keep my account open
  • You may need to provide collateral or a personal guarantee

What's the Difference Between a Line of Credit and a Business Loan?

While a business loan and a line of credit can be useful funding sources for small businesses, they have some key differences. Mainly in the requirements needed to qualify and apply and their main use cases.

Qualification Requirements

Many lenders prefer businesses with good credit ratings (600 and above) to qualify for a small business loan and want to see that this business has been operating for more than a year. You can still get the loan if you don't meet these requirements; however, terms like interest rates may be unfavorable.

The approval process for a business line of credit is similar to business loans. But it's easier to qualify for a line of credit. Many lenders provide lines of credit to businesses with a relatively lower credit score (560 and above).

Related Reading: Is my Business Lendable? Common Requirements Lenders Look For.

Business Loan vs. Line of Credit

Business loans are typically used to finance long-term or one-time projects like purchasing major equipment, building renovations, growth investments, debt consolidation or refinance, and lease improvements. Just be sure to do your due diligence and review lender requirements to learn about any restrictions on using the business loan before applying for one.

On the other hand, business lines of credit are often used to finance emergency expenses. They can also be used as short-term working capital when funds are tight (like during slow seasons), paying employees, covering rent, and buying inventory.  

What's Best For Your Business?

Choosing between a business loan and a line of credit can be an uphill task if you don't know the specific details of both. The right choice depends on how much you need, how you intend to use it if you want flexible or predictable payments, and your business and personal credit score. 

Take your time in weighing your options against each other to make an informed decision that works best for you and your small business! Ready to start searching? Find your next lender through our Capital Marketplace today!the friday fund