Line of Credit vs. Term Loan: Which Is Best For My Business?
A traditional term loan is probably the most common form of business loan, so itâs pretty easy to understand. You borrow a lump sum of moneyâusually for a specific purchase youâre making for your businessâand pay the loan back over a set term, most often at a fixed interest rate.
$25,000 to $500,000
1 - 5 years
7 - 30%
As little as 2 days
Plenty of businesses can qualify for a traditional term loanâas long as youâve been in business for a bit, have a good credit score, and are generating revenue.
(See more on a term loanâs minimum qualifications below.)
Not all term loans are the same, though: the interest rate, length of the term, and maximum loan size depends on your business revenues and credit rating.
Since traditional term loans have longer repayment periods than short-term loans, your businessâs financials and credit score are more important.
**Based on past Fundera customers.
Every business could use some extra cash. Whether itâs for an equipment upgrade, an order of inventory, or a new employee, a business loan could always help out.
But how can you find funding that your business can afford?
We deal with all sorts of businesses here at Fundera, and weâve got some insight into which applications lead to which loans.
Take a look at how a term loan worksâand what youâll need to qualify for one. That will help you understand whether a term loan is the right product for you.
Quickâimagine a business loan.
You probably thought of a term loan, since itâs the most common kind of business loan out there.
And simply put, theyâre all about predictability.
You get a predetermined amount of money with a set interest rate, which might be fixed or variable. Then you pay that cash back over an agreed-upon amount of time in regular intervals and increments.
When it comes to term loans, thereâs nothing unexpected. You know exactly what youâre getting into.
That doesnât mean all term loans are exactly the same, though.
Depending on your small businessâs growth needs, credit rating, cash flow, revenue, and more, there are plenty of different term loans available.
In fact, you can get term loans with lengths and payment structures as varied as 1 year with daily payments to 5 years with monthly paymentsâand everything in between.
Similarly, loan amounts and interest rates vary according to your businessâs needs and history. You can get more or less moneyâat higher or lower rates.
The exact details of your term loan depend on your businessâs financials, but the structure will stay the same.
Traditional term loans are a wide category of business financing, available both from traditional banks and alternative non-bank lenders.
Getting a traditional term loan isnât always easy, especially if youâve got a low credit score or no collateral to secure that cash with.
In fact, collateral might be a requirement for a term loanâdepending on the rest of your businessâs financialsâand you risk losing that collateral if you canât repay your loan.
And while many of these lenders might not ask for a specific piece of collateral but, instead, put a âblanket lienâ on your business, the same risk still applies.
(Learn more about blanket liens here.)
Donât forget: when you apply for a small business term loan, make sure to ask if there are any prepayment penalties or other fees you should be aware of. Go over the exact terms with the lender so you can arrive at a monthly payment you know you can afford.
Your biggest help?
A term loanâs predictability.
You should be able to figure out whether a term loan will help or hurt your business from the get-go. Just understand the calculations beforehand and plan the coming months or years of spending carefully.
The point of a term loan: to help you finance something big for your business.
Whether you need to make a specific equipment or inventory purchase, want more working capital, need to refinance other business debts, are looking to meet tax or payroll obligations, or something else entirely, a small business term loan can help you out.
And as it turns out, there are few loan use restrictions, if anyâthough, generally speaking, itâs best practice to spend that money creating more revenue for your business.
Since borrowing isnât free, you want to come out of a loan with more money than you began with. Itâs all in the planning ahead.
If used the right way, traditional term loans can help you push your business to the next levelâintroducing new equipment, locations, products, or marketing campaigns into your toolbox.
To distinguish traditional term loans from their shorter-term alternatives, we usually refer to them as âmedium-termâ loans instead.
Exactly the right question to ask. Thankfully, the price tag of a term loan is pretty easy to figure out. Letâs take a look at an example.
Congratulationsâyouâve qualified for a term loan!
Letâs say youâre borrowing $25,000 from a lender at a 12% interest rate and a 5-year term.
Given the longer length of that traditional term loan, youâll most likely have a monthly payment of about $556. (Term loans can come with weekly payments, too.)
Thatâs a predictable expense you can easily understand and plan your financials around.
But hereâs the thing: not every payment goes toward the same thing.
Traditional term loans amortize, which means you donât pay equal parts interest and principal (or the amount you borrowed) from month to month. Instead, lenders usually stack interest payments early on and leave your principal payments for later.
That way, even if you pay off your loan early and get the rest of the interest forgiven, youâve still paid most of it to the lender.
In other wordsâ¦
You might save less than youâd think by paying your term loan off before itâs due.
However, your monthly payment is still the same amountâitâs just the proportion of interest to principal that changes.
In order to understand your loan completely, make sure to ask your lender for an amortization schedule.