What’s the Difference Between Business Lines of Credits and Term Loans?
Business lines of credit are good for a business to smooth out or increase cash flow. They are also good for a business that needs a reserve fund for cash flow. They are also good for a business that needs a reserve fund for unexpected or emergency expenses. Lines of credit have higher interest rates than term loans, but they are very versatile.
A business term loan is a lump sum of money or capital in a specified amount. You pay this loan back with a specified repayment schedule and a fixed date. The payment terms or principal and interest rates are fixed costs.
Business Line of Credit
A business line of credit is right for your business if you are looking for a safety net for your business. It is like working capital, and funds are available for your business while you wait on accounts receivable, government help, or more business.
A business line of credit is not a lump sum; it is a line of credit with a set number of dollars. However, for the duration of that line of credit, you can draw on the money at will. As a result, you accumulate debt up to a maximum equal to your credit limit. A line of credit is revolving. You pay off your debt, and it becomes available to use again.
Business lines of credit can be:
- Unsecured Line of Credit or an unsecured amount that isn’t secured by an asset. You will be asked to sign a personal guarantee.
- Asset-Back Line of Credit is based on the number of assets you provide as collateral. The value of your assets can change, and your credit limit may also change.
- Invoice-blocked lines of credit are asset-backed lines of credit that use your invoices as security. (This is not invoice factoring.)
Lines of credit are very convenient, and you do not have to apply for more funding all the time. Instead, you use the money that is in your line of credit. In addition, you may find that lines of credit have additional perks, as they come with cards allowing you to use your line of credit like a credit card. Some may even offer you reward programs like those of credit cards.
Think about it. You may need a line of credit if:
- You have many small expenses over an extended period,
- You need access to cash when you want it,
- You want a financial cushion to fall back on if emergencies come up,
- You want a reusable source of funding.
Determining if you need a line of credit depends on the type of expenses you are anticipating. For example, if you have vague financial needs and need a cushion, go for a business line of credit.
Three types of term loans are available- short, medium, and long term. Each type of term loan is paid off over an extended period that is usually greater than three years. How much of a term loan you can get depends on your businesses’ annual sales, existing debt, and creditworthiness. For example, most lenders will only lend 10 percent up to 30 percent of a businesses’ annual revenue. In addition, you need to be cash-flow positive to apply for a term loan.
Terms loan have different amounts and interest rates, but they give you funding in a lump sum with repayment starting within 30 days. Repay a term loan over a set time from a few months or up to ten years.
Short-term loans are less than a year’s term and use a fixed fee and interest structure. Repayment is rapid, and payments are made daily, monthly, or weekly. Medium and long-term loans accumulate interest over time and are generally repaid monthly.
Short-term loans are quick, with funding available within a business day or so. However, long-term loan approval tends to be slow, but long-term loans have better rates, but they demand collateral. Term loans are perfect if your business is seasonal, and you are attempting to grow and expand. You can also take advantage of a term loan if you need to make a large purchase or have a pressing expense. If you need a long-term loan, your repayment can stretch out for years. This does alleviate the pain of paying back funds.
Term loans are sometimes easier to receive than a line of credit. The alternative lending market may be a good place to go for a term loan. They deemphasize credit scores, and if you have a healthy business, you may get a term loan.
In most cases, term loans have better rates. Of course, you will pay a high premium for a line of credit, but term loans have set interest rates that follow the current market.
Use a term loan if:
- You know precisely how much you need to borrow,
- You don’t have access to credit and need money,
- It would help if you had a large lump sum of money,
- You need time to pay off your loan.
To receive a business loan, you need four general requirements. These are good credit scores, positive annual revenue, a business plan, and collateral. In addition, there may be another supporting document that you need to qualify for a business loan. These can be your business license, business insurance, commercial leases, payroll records, incorporation documents, and current added financial obligations. Applying for a business loan may reach into every corner of your personal and business financial history. Therefore, make sure your records are in good order before you consider a term loan.
Whether a term loan or a business line of credit is best for your business depends on the quantities of expenses you are paying. For example, a term loan is preferable if you need a lump sum and can state the intended use, plus you can pay the money back over the next few years.
If your financial needs are vague and your ability to repay quickly is not solid, a line of credit might be the way you need to go.
Find a lender that works for you. You will probably need at least a 600 credit score, $100,000+ revenue, and be in business for at least a year. Then, check out the application process. If you want something straightforward, either loan can offer this type of application