A LOAN VS. A LINE OF CREDIT – WHICH ONE IS BEST FOR YOUR BUSINESS?

Business owners have multiple options in terms of potential funding sources. They can choose between secured business loans, startup grants, venture funding, and lines of credit.

In addition to these, there are alternatives such as unsecured business loans and crowdfunding. Business owners should choose the funding option that is the most suitable for them. How do you arrive at this decision? The first step is to understand the definition of funding options like loans and lines of credit.

 

What is a Loan?

A loan can be defined as a source of funding that is borrowed from an external source and one that needs to be paid back over time with interest.

What is a Line of Credit?

A line of credit is a type of credit facility that is extended to you by a bank. A line of credit enables borrowers to draw from the facility as and when the need arises. Keep reading to compare the benefits of traditional loans and lines of credit.

 

The Differences Between A Loan Vs. A Line Of Credit

The key differences between a traditional loan and a line of credit are highlighted below:

  • The primary difference is that a traditional loan tends to have fixed interest rates, while a line of credit can be more open-ended with interest rates that are variable.
  • Another difference is that traditional loans tend to have longer terms. These loans could last up to 20 years potentially. Comparatively, a line of credit for small businesses has a typical term of just three years.
  • The average amount that you could borrow under a traditional loan could be much higher than a line of credit. Traditional loans allow you to borrow amounts up to $5 million or more, which is significantly higher than a line of credit.
  • The money that you receive as part of a traditional loan is paid upfront. However, you can draw from a line of credit whenever you need funds.

 

When Is A Business Loan A Better Idea?

There are certain situations when taking out a loan is a much better strategy for your small business:

  • You should opt for a loan if you want to make a one-time investment or purchase. You will receive the amount upfront and will be able to repay the loan in regular installments.
  • A loan will also be a good option if you are looking to minimize interest liability. This is because loans tend to have lower rates of interest and tend to be fixed. Accordingly, taking out a loan could be more cost-effective.

 

When Is A Line Of Credit A Better Idea?

On the other hand, there are also certain instances when a line of credit would be a better option for businesses:

  • If you know your business is going to need access to cash on an ongoing basis, then a line of credit is ideal. It would enable you to draw funds whenever you need to do so, without having to apply for a loan repeatedly.
  • Another case in which a line of credit is more appropriate is if you are unsure about the timeline of future expenses. If you know that you would need money in the future, but do not know exactly when, then you could opt for this type of financing.

 

Things To Look Out For In Any Case

There are certain things that you need to keep in mind for both these types of funding instruments:

  • Can I get a business loan with bad credit? The answer depends on several criteria, but the likelihood of approval for a small business loan with bad credit is low. Similarly, a line of credit may not be approved if you have large existing debts. Even if approved, bad credit business loans are not a great proposition given higher interest rates. Maintaining a good credit score is crucial for obtaining the best loan terms.
  • The fees that accompany both these forms of borrowing – Traditional loans tend to have lower processing fees associated with them, but you need to compare them in any case.
  • You also need to analyze the repayment schedules – and if there are any prepayment penalties that would accompany the early retirement of the loan or line of credit.

 

Conclusion

Both forms of financing have their respective pros and cons. Eventually, you need to make an informed decision on the basis of business needs and nothing more. If you require money upfront, then a traditional loan would be best. However, if you want to borrow at set intervals, then a line of credit might be more suitable.

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