Business Line of Credit vs Term Loan

By: Micah

Do you know the the difference between a business line of credit and a business loan when should you use one over the other?

The next time your business has the needs to borrow you need to know exactly what product is appropriate for you.

First off let’s define these products.  A business loan is where you get a lump sum of money and you have to pay it back
over a specified period of time that period could range from 12 months to 20 years.  It may be amortized, and it may have a generous prepayment discount, or not.  (For example, a cash advance does not have a good one.)

With a business line of credit you’re going to get a credit limit that the lender predetermines and you get to use the funds how you see fit, whenever you’ll need them.

A business loan can only be used once once you pay it off at least 50% – which is when you no longer have access to it.

A business line of credit is open-ended.  Any principle paid down towards the balance, you will have access to that amount in your credit limit.

Now let’s discuss the payments.  In a business loan you have a fixed monthly, and in some cases weekly, payment.  A business line a credit you’re allowed flexibility on how much you want to pay every month it’ll range anywhere from paying interest-only, or an amortization over many months or years, and you can even pay down your full balance to save on interest.

Now, when do you want to use one over the other?  You would get a business loan when the need for it, suddenly before the need arises, or if the goal is to get a much larger amount of capital up-front. A business line of credit before you need the funds so when would you use each product.

Let’s go to an example let’s say you have a metal manufacturing business and you want to replace all your energy guzzling 1970s machinery to the brand-new state-of-the-art latest and greatest technology machinery.  In such a case you would use a business loan because the use of the proceeds is long-term in nature.

Now let’s say your manufacturing company needs to purchase raw materials to make the finished products.  In this case you want to use a business line of credit because it’s a revolving need over a short period of time.

In general, one will always want to have a credit line in place for working capital, rather than a term or business loan, or even a cash advance.  However, if the need arises suddenly, there are places for a cash advance of sorts.  The key is not having debt hanging around and paying too much for debt.  Credit lines, even if they are more expensive or lower amounts offered up-front, are a better solution for working capital due their cyclical nature.

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