When starting, building, or growing a business, you will need some money to fund the necessary things like inventory, supply, manpower, equipment, etc. Where do you get the funds? While some businesses have cash-on-hand that they use to operate the enterprise, others get the funds from business loans and business line of credit.
These two funding options both serve their purpose but, in a way, unique from each other. Determining what their differences are will help you decide which type of funding is best for you and your business.
Business Loan & Business Line of Credit: 8 Differences
Here are the things that make business loans different from a business line of credit:
1. One-time use versus multiple use.
Business loans can only be used for a single time while you have multiple chances to use a business line of credit for your start-up or business-growing needs.
2. The timing of getting the loan.
In general, you will only get a business loan once you actually need it. This is because you can use it only once, so you are waiting for that one specifically important purpose before applying for one. On the other hand, a line of credit for business is something that you get even before you need it and can serve as a ‘stand-by’ funding source.
3. Business loans require you to make a monthly payment.
With business loans, you pay for monthly dues that do not change, aside from a few exceptions. The monthly payments start right away after the loan has been made. Payments for the line of credit, on the other hand, depend on the amount you borrow. Even if you have an existing line of credit, you won’t have to pay anything if you haven’t used anything.
4. The cost of closing the accounts.
Compared with the cost of closing a business line of credit, the cost of business loan is always higher. While there are some exceptions to this rule, closing most business loans will cost you 2-7% of your total loan amount whereas closing a line of credit is very minimal. Hence, this is one of the biggest factors that affect the choice between these two.
5. Business loans come in fixed amortization periods.
Because business loans are typically fixed term, they have higher monthly payments compared to the payments required for a line of credit. For instance, if you are getting a loan worth $50,000, you are more likely to pay at least $400 to as much as $700 a month MORE compared to the line of credit.
6. If you are going long-term, use a business loan.
For long-term debts that you plan to pay off after 2-6 years, it is ideal to get a business loan instead of a line of credit. Nevertheless, lines of credit are still best for those short-term, unexpected funding needs like financing marketing, equipment, receivables, and payroll. Lines of credit are excellent for these cash-flow issues, but please make sure that you do not use up your credit lines on unimportant business purchases, such as unnecessary office upgrades. It is advised to use your credit line only for revenue-generating activities.
Revenue-generating activities like a marketing campaign are justifiable because you will be able to generate additional income and grow your business through this.
7. Business loans have higher rates.
Expect to pay higher interest rates with business loans, but these are typically fixed rates and won’t change over time. On the other hand, business credit lines have lower, but variable interest rates. Hence, if you manage your credit lines poorly and make late payments and over-the-limit credits, interest rates can go up plus you may have to pay for additional charges. Interest rates for business lines of credit can improve with proper credit management.
8. Business loans are driven by interest rates while credit lines are not.
With loans, interest rates are important. Credit lines, on the other hand, are not very rate sensitive. A business line of credit is used mainly for short-term funding needs, so it is crucial to have a cash-flow-friendly payment term. Hence, even if the rate is actually low, it is important to keep the monthly payments as low as possible and in balance with your cash flow.
Now that you know the differences between the two, it will be now easier to decide which will work best for you and your business. Weigh the advantages and disadvantages of these two funding options carefully, so you won’t have to face any confusion and drawbacks.