The Difference Between a Line of Credit and a Loan for Your Business

Posted at February 19, 2020 » By : » Categories : Business Funding »
difference between line of credit and loan

If you have a business and want to expand, add more inventory, etc., then at some point you’ll need to borrow money. It’s common practice for businesses, and banks are happy to provide the money to help successful businesses become even more profitable.

The most common types of business borrowing are business loans and lines of credit. They are similar concepts, but different programs and many business owners know the difference between line of credit and loan.

We’ll examine both and tell you what they are so you can decide which one is right for your business. You’ll be able to make an educated decision after reading this article.

Difference Between Line of Credit and Loan

When it comes to the nuts and bolts of a loan and a line of credit, it’s about a timed loan and a loan where you can access money at any time.

A business loan is like any other type of loan you might get from a bank. You ask for a specific amount, the bank gives you an interest rate and monthly payments and you pay it off over a set time period.

A line of credit isn’t really a loan. It’s a set amount of money that you have access to at any time. You take the money out and then must pay it back with interest and have a minimum monthly payment. You can take more out even if you’re paying off an earlier amount.

Once you meet the limit, you can’t take any more until some of it is paid back.

When Do You Need the Money?

Was there a disaster and your inventory damaged or do you need emergency repairs to your store and don’t have the cash one hand? This would be a perfect opportunity to use your business line of credit.

It’s available at any time and you don’t need to take out a large sum. You take out what you need for the project and the rest stays available.

A business line of credit is perfect for the unexpected. Business loans can take time to apply for, be approved, and get the money. If there’s an emergency, you don’t have the time to wait.

A line of credit has ease of access. It’s there for you when you need it.

If you have a major project you want to do, but don’t have the money, then you might consider a business loan. You can get an estimate for the project and ask for that specific amount. Business loans are ideal for projects you can plan for and are more expensive.

Business Loans Are One Time Opportunities

When you have a project that uses a business loan, you get one lump sum of money that you can use how you see fit. The goal is for that large lump sum to pay for the project. From then on, you have a monthly payment and a loan period.

Lines of credit can be used at any time. You can take $50,000 out on Monday and another $50,000 on Friday if you need it. If you aren’t using the money, then it sits there ready to use and you don’t have to make any payments at all.

The benefit of the lump sum is you have everything you need all at once. It’s planned and expected, so you’re prepared for the monthly fee and time it will take to pay it back. You may not be prepared when you take money out of a line of credit.

It’s important to make the minimum monthly payment on the amount you took out of the line of credit even if you needed it for an emergency and couldn’t plan for the debt.

Fixed Versus Varied Interest Rate

Business loans tend to have higher interest rates than lines of credit. A loan is a large lump sum, and it carries more risk than the smaller amounts you take out of a line of credit. The good news is the interest rates for business loans are usually fixed.

You pay a set amount for the duration of the loan and that amount never fluctuates. A business line of credit can have a lower interest rate, but it’s variable. This means your minimum payments could vary from month to month depending on the current interest rate.

Long-Term and Short-Term Goals

Lines of credit are ideal for short-term business goals, such as if you have a bad month and need a little extra for payroll or there is a marketing opportunity that arises you want to participate in. It’s not designed for long-term projects.

Ideally, you borrow the money in one month and then pay it back over the next couple. It’s not something you have longer-term debt for.

On the other hand, a business loan is designed to be paid back over years, not months.

You’ll want to use the bulk of your line of credit money for emergencies or fast revenue-generating opportunities. Business loans are for major planned products such as updating equipment, expanding your store, etc.

Closing Costs Are Higher for Business Loans

The closing costs for a business loan can be anywhere from 2-7 percent. Depending on how much you borrow, that could be a significant amount. A line of credit has usually little or no closing costs, so you’re saving money with a line of credit.

When determining which is best for you, keep this in mind when factoring in cost.

Which Is Best for Your Business?

When it comes to the difference between line of credit and loan, it’s about what do you need it for? Is it a set project with a definitive cost or money for small projects that gets paid back quickly?

Which is best for you depends on your business needs and what you plan to do with the money. If you want to learn more about lines of credit and loans, then please explore our site.