A term loan is a lump sum of capital that you pay back over a specific time period (or “term”) with a set interest rate. This type of financing is best for specific, one-off expenses like purchasing inventory, refinancing existing debt, or opening a new location. A line of credit gives you access to a pool of funds from which you can draw against for any business-related purpose. You only have to repay the funds you use, plus interest. Lines of credit are best for ongoing operating expenses or an emergency fund.
While both of these financing options can offer your business the capital it needs, these two business loan products operate differently and serve different business needs. Not sure which to choose? This term loan vs. line of credit comparison is here to help. Let’s get started.
|Line of Credit
Best for specific, one-off expenses like purchasing inventory, refinancing existing debt, or opening a new location
Best for ongoing operating expenses, such as payroll, seasonal expenses, unexpected costs, or as an emergency fund
$25,000 to $500,000
$10,000 to over $1 million
7% to 30%
7% to 25%
One to five years
Six months to five years
Origination fees, packaging fees, prepayment penalties, and more may apply
Draw fees, inactivity fees, withdrawal minimums, and more may apply
-Over three years in business
-680+ credit score
-$300,000+ annual revenue
-Over one year in business
-630+ credit score
-$180,000+ annual revenue
A term loan is likely what you think of when you imagine a traditional business loan. With a term loan, you receive a lump sum of capital that you pay back over a specific time period (or “term”) with a set interest rate, which might be fixed or variable.
Term loans typically have repayment terms of one to five years with amounts ranging from $25,000 to $500,000. No matter when you start using the money from your term loan, you will start making payments to the lender immediately, and these payments will be on a set schedule (anywhere from daily to monthly).
Keep in mind, term loans can also come with fees besides interest, including origination fees, packaging fees, prepayment penalties, and so on. A term loan calculator can help you see how much debt you can afford.
Typically, business owners use the proceeds of term loans to finance a specific, one-off investment for their business, such as opening a new location, buying additional inventory, refinancing existing debt, or taking advantage of a new business opportunity.
Much like a personal loan, in order to get a business term loan, you’ll need to show exactly why you need to borrow the money (what you plan to use the money for and how that will help your business increase sales and profits). If your financial projections convince lenders that these changes will increase your sales and profits—and you have strong business credentials—the lender will feel confident that your business will be able to make the repayment.
Both banks and alternative lenders offer term loans, and they typically require strong business credentials. In order to qualify for a term loan, you’ll likely need at least three years of business history, a credit score of 680 or higher, and over $300,000 in annual business revenue. The better your qualifications, the higher loan amount, longer repayment terms, and lower interest rates you can expect.
You will also likely be asked to provide collateral for your term loan, or the lender may place a blanket lien on your business to ensure that they can recoup their money if you default on the loan.
A business line of credit is one of the most flexible financing products on the market. You can think of a line of credit as a more powerful credit card. If approved, a lender will extend you a credit limit (say, $50,000, for instance) from which you can draw against at any time and for any business purpose.
Unlike a term loan, you only pay back what you use (plus interest). Another unique quality of lines of credit is they are usually revolving, meaning once you pay back what you’ve used, your balance refills to its original value and you can draw against it again and again. Therefore, many businesses keep lines of credit in their back pocket for unexpected emergencies or opportunities they need to react to quickly.
Lines of credit can range from $10,000 to over $1 million and, while they don’t have hard-and-fast term lengths like term loans do, typically you may have between six months and five years. As with term loans, you’ll want to make sure you understand all of the fees associated with your line of credit. Depending on the lender, you may be subject to draw fees, inactivity fees, withdrawal minimums and more.
A business line of credit is sometimes called an operating line of credit because its purpose is to help finance ongoing operating expenses. Business lines of credit are best for short-term financing needs as well as ongoing operating expenses, such as payroll, seasonal expenses, unexpected payments, or temporary cash flow shortages.
Plus, since you don’t have to repay your line of credit until you start using it, many businesses apply for this type of funding to keep as an emergency fund of sorts for their business. That’s why the best time to apply for a business line of credit is before you need it.
As is the case with term loans, the stronger your business credentials, the better terms you’ll receive for a line of credit. That said, lines of credit typically have less stringent requirements as compared to term loans. Generally, lenders want to see at least one year of business history, a credit score of at least 630, and over $180,000 in annual revenue.
Business lines of credit can be secured—meaning they’re backed by collateral like inventory, accounts receivable, etc.—or unsecured, backed by a personal guarantee.
Now that you have a general understanding of both business term loans and lines of credit, let’s take a closer look at how these two financing products differ.
While there are many differences between term loans vs. lines of credit, these financing products do have some things in common.
When deciding which is best for your business, the first thing you should consider is what you need to use the funds for. If you need to finance a specific, one-time expense, then a term loan is your best option. However, if you’re looking for funds to cover ongoing operating expenses or you want a reserve to keep in case of an emergency, then a line of credit is best for you.
While these are two very different financing solutions, both term loans and lines of credit offer flexible solutions for your business. With a strong credit score, at least a year in business, and solid revenue, you have the best chance to be approved for the amount you need with the most favorable repayment terms.
Rieva Lesonsky is a contributing writer for Fundera.
Rieva has over 30 years of experience covering, consulting and speaking to small businesses owners and entrepreneurs. She covers small business trends, employment, and leadership advice for the Fundera Ledger. She’s the CEO of GrowBiz Media, a media company specializing in small business and entrepreneurship. Before GrowBiz Media, Rieva was the editorial director at Entrepreneur Magazine.