Business loan vs. business line of credit: Which is right for you?

According to The Federal Reserve’s most recent Small Business Credit Survey, 40% of small businesses in the U.S. applied for financing in 2022. The reasons small businesses sought financing ranged from maintaining operations and replacing capital assets to financing new opportunities. Of those that applied for financing, 79% were approved for some, most or all of the amount.

If you’re a small business owner seeking financing to smooth out cash flow or grow your operation, you’re not alone. Here’s what to know about business loans vs. business lines of credit and which makes the most sense for your situation.  

What is a business loan?

A business loan is a lump-sum loan that small businesses can use to cover costs. These loans are available through brick-and-mortar banks, credit unions and online banks. Some organizations also back specific types of business loans like the Community Development Financial Institutions Fund (CDFI) and the U.S. Small Business Administration (SBA). 

Business loans can be either secured, requiring an asset of value as collateral, or unsecured loans. Common collateral for secured business loans includes equipment, vehicles, and real property (typically land and buildings). 

How does a business loan work?

Interest rates

As with other loans, when you borrow a business loan, you repay the total loan amount plus interest. Interest rates on business loans vary by lender, and can also vary based on your credit and business financials. Business borrowers with excellent credit and a strong financial history are more likely to qualify for a loan with a lower rate. Lenders may not be forthcoming with interest rates on business loans, so be sure to inquire about rates as you compare options.

Loan amounts

If you need a personal loan, you could borrow as little as $250 or as much as $100,000, depending on the lender. But small business loans tend to be larger than personal loans. It’s common to see minimum loan amounts of $5,000 and maximum loan amounts of up to $1 million or even more. The amount you qualify for will depend on factors including your credit and financial history. 

Repayment terms

Repayment terms for business loans vary depending on the type of loan. For instance, term loans and equipment financing typically have terms of up to 10 years, some microloans go up to 7 years and SBA loans can go up to 25 years.

Business loan pros 

• Funds can be used for several purposes.
• Range of loan amounts available.
• May prevent the need to take on investors.
• May have lower rates than business credit cards and lines of credit.

Business loan cons

• Could lose collateral if you default on a secured loan.
• Significant documentation required during the application process.
• Typically have many strict qualifications to meet.

What is a business line of credit?

Business lines of credit are credit lines that business owners can borrow against on an as-needed basis. For instance, the lender offering the line of credit may approve the borrower for a total line, such as $100,000, and the borrower has the flexibility to draw down on that amount or not. They’ll only repay what they borrow, plus interest, over a set period. 

Like small business loans, business lines of credit can be either secured or unsecured. Some lenders may offer both options. They can also be either non-revolving or revolving. If a line of credit is revolving, it means you can borrow up to your total limit, pay down your balance, and borrow against it again.  

How does a business line of credit work?

Interest rates

As with business loans, lenders may not be forthcoming about the rates they offer on business credit lines. So before you apply, be sure to inquire about rates. In general, the rate you receive on a business line of credit may be higher than what you’d get with a business loan. But it’s essential to compare rates to find the most affordable financing for your needs. 

Loan amounts

Lenders commonly offer business lines of credit ranging from $5,000 to $250,000, but total credit lines can vary by lender. For instance, American Express offers a business credit line as small as $2,000, while OnDeck’s smallest business credit line is $6,000. 

Repayment terms

Like repayment terms for business loans, repayment terms for business lines of credit tend to be short. It’s common to see terms of two years or less, though certain credit lines may have longer terms. The SBA Express program, for example, may have a repayment term of up to 10 years. 

Business line of credit pros 

• Flexible borrowing option (you don’t have to use your whole line of credit).
• Funds can be used for several purposes.
• Can borrow against revolving credit lines repeatedly.
• May replace the need to take on investors.
• May have lower rates than business credit cards.

Business line of credit cons

• Could lose collateral if you default on a secured credit line.
• In-depth application process.
• Typically have many strict qualifications to meet.

Business loan vs. business line of credit

How to choose between a business loan vs. a business line of credit

“Interest and use case are the main drivers for deciding on whether to go with a business line of credit vs. loan,” says Jeanne Hardy, founder and CEO of Creative Business Inc., a New York-based small business advisory firm.

“A line of credit or revolving loan is flexible; you pay interest on what has been utilized and is perfect for short-term cash flow bridges. A business loan or term loan is best for large fixed-asset purchases or leasehold improvements. Interest rates on loans tend to be lower than line of credit rates,” she explains.

For business owners that know exactly what they need to borrow, a lump-sum loan could be a good solution. But those who need to smooth out cash flow may be better off with a business line of credit. 

With any type of financing, it’s essential to compare available loan amounts, repayment terms, funding timeframe, rates and requirements for borrowers. Doing so will help you find affordable financing that best meets your business needs.