What’s The Difference Between Line of Credit and Small Business Loans?
As you will already know, the cash that your small business is handling is one of the most important resources that you have, and it will help you to do everything, from your standard operating procedures to investing into new products, people and services to help expand and grow bigger, and therefore, more successful.
According to statistics, small businesses play a major role in economic growth by creating more jobs than larger businesses. But 27% of them stated they were not able to receive a funding they needed. Some of small businesses come with investments from the owners and their family and friends, according to SBA.
However, there are going to be times where you don’t have this cash to hand, and you’ll instead need to turn to a cash provider who can give you the funds you need to complete your next project or task. If you’ve been shopping around already, you’ll have already noticed several paths you can take.
Most commonly, there are two channels to choose from; Line of Credit and Small Business Loans. Each has their own pros and cons, but as a responsible business owner, you’ll want to make sure that you’re making the right decision.
Today, we’re going to explore the ins and outs of each, giving you everything you need to know to do the best for your business.
What is a Line of Credit
As the title of our initial channel suggests, a Line of Credit is very similar to a personal credit card and works very much in the same way. This is known as a revolving loan. In most cases, you’ll be given a credit limit, which in business could be any figure that you agree on, potentially up to hundreds of thousands of dollars.
You can access this money wherever you want, whenever you want, and then you’ll make monthly repayments to pay it off. Of course, an agreed interest rate will also be applied to the line of credit, so the provider can profit.
Even if you’ve paid off part of your balance, you can still spend that credit again if you require. Lines of credit also have typically lower closing costs if you decide to close your account in one payment.
Taylor Olson, a founder of Academized, shares, “When we were looking for some short-term cash to boost our supplies during the busy period, we took out a line of credit just to see us through. Of course, the busy period came, and we made the money back, making it the ideal solution for our business”.
What is a Small Business Loan?
More commonly referred to as a term loan, this is a loan where you will be given a lump sum of cash or credit into your business bank account but, unlike a credit card, this must be paid off within a set term, or a fixed amount of time. These loans can vary depending on their size, purpose and terms of the agreement, and can last anywhere from six months to twenty years.
Monthly repayments will be made with an interest rate added on. This interest rate is typically fixed but may be variable, depending on the agreement that you opt-in for. A business loan in this sense is very much similar to the mortgage you would get for your house, or starting a business as Australian Help did. Loans are usually a large amount, sometimes even into the millions of dollars.
As an individual and business, you’ll have your credit rating checked to ensure that you can pay back the loan. This is also what will typically decide your interest rate.
Jeremy Dawson, an entrepreneur working with Paper Fellows, says, “We needed a new printing press within our business, so we took out a sizable business loan for the bank, worked how much money that could make a year, and then worked out how long it would take to pay itself off. This was an easy way to manage payment, so the rest of the business was not affected.”
Most loans will also need you to ‘collateralise’ items of your business or value in case you can’t repay it, known as a secured loan. This can include property, business assets and inventory. If you have a business with a long track record of good credit, you may also be entitled to an unsecured loan.
Which Type of Credit is Best for My Business
As we mentioned above, there are pros and cons to both forms of credit, so it’s up to you to decide which one is best for your business. Typically, small business loans are used for larger payments and longer terms. There also have many benefits which include;
- Fixed Interest Rates
In most cases, a small business loan will have fixed interest rates. This ensures that you always know what repayment figure you’re going to pay every month, making it very easy for you to manage your books and accounts.
- Standard Secure Requirements
For many business loans, you can use the inventory that you’re purchasing with your loan as the collateral for the loan itself, meaning if things aren’t as positive as you plan for, the rest of your business is not affected.
- Best for the Books
It’s far easier to manage money that comes with a small business loan because you can extend it over longer periods of time. For example, if you buy a piece of equipment, you might like to dedicate the next new years of profit to pay off a 10-year loan. This makes everything incredibly easy to manage.
- Lower Interest Rates
While the interest rates are typically fixed on small business loans, another benefit that they provide is overall lower interest rates, especially when compared to the typical rates that lines of credit have.While these are some great benefits that a small business loan can bring to your business, as well as the much-needed funds to expand, there are many benefits that a line of credit can provide. These include:
- Quick Access to Cash
Since you’ll get a card with your credit, you’ll be able to withdraw and spend as much money as you need to, whenever you need it.
- No Costs Until Used
If you take out a line of credit, perhaps as an emergency, you will never have to pay any interest, fees or costs until you start to use it for the first time.
Once you have repaid off some of your outstanding credit, you can then use that credit again and repeat indefinitely.
- No Security Needed
Unlike a small business loan, you won’t have to put assets or inventory in line with your credit in order to obtain or use it, protecting your business.
- Flexible Payment Options
While most lines of credit will have a minimal payback monthly fee, you can easily pay off more if you wish, meaning you can repay what you owe quicker, therefore paying less interest.
- Quick Access to Cash
- Fixed Interest Rates
As you can see, there are many benefits that come with each form of credit or loan, so it’s up to you to decide which one is best for your business. As a rule of thumb, if you’re looking for large amounts of money over a longer period of time, choose a small business loan. If you’re looking for smaller amounts of money over a shorter period of time, choose a line of credit.