If you’ve been looking into getting financing for your business, it’s likely you’re already familiar with the basics of business lines of credit and business term loans. But do you know which will be best for your business?

In this article, we’ll compare business lines of credit with business term loans to help you decide which type of financing will yield the results you’re looking for.

Key Takeaways

• Business lines of credit and business term loans have similar eligibility requirements and repayment schedules, but business lines of credit have a shorter funding timeline, no use restrictions, and no collateral requirements.
• However, you can borrow more with a business term loan, and the loan’s term can be anywhere from a few years to 30 years. Also, your interest rate will often be lower.

Business Line of Credit vs Loan

Eligibility Requirements

The eligibility requirements for business lines of credit and business term loans are similar in many respects, but the specific criteria you’ll need to meet to secure either type of financing is determined by the lender you choose.

To secure a business line of credit with favorable terms, you’ll likely need to have a personal credit score of 680 or higher, especially if you want to get funding through a traditional lender, such as a bank or credit union. You’ll also need a Dun & Bradstreet PAYDEX business credit score of 80 or higher or an Experian Intelliscore of 76 or higher.

If you’re looking to get funding from an online lender, a personal credit score between 600 and 680, and an Experian Intelliscore of 50-75 are often the requirements.

The same is true for business term loans. However, if your goal is to secure a Small Business Administration (SBA) loan, you’ll need a personal credit score of at least 620.

Additionally, to secure either type of financing, you’ll need to show that your business’ finances are in good shape. Therefore, you’ll need to submit balance sheets, income statements, profit-and-loss (P&L) statements, tax returns, and other important financial documents with your application.

Also, lenders will want to see that your business has been operating for at least two years. If your business hasn’t been operating for two years, but you can show 6-12 months of consistent revenue and profit, your business’ limited history shouldn’t prevent you from securing financing.

Regarding credit score requirements, while it’s possible to get a business line of credit or a business term loan with bad credit, there are significant costs associated with this, and you should know what these are before you go this route. In general, the lower your credit score, the higher the interest rate and stricter the borrowing terms.

Lastly, if you’re looking to take out an SBA loan, there are additional requirements you’ll have to satisfy to qualify for a 7(a) or 504 loan.

Specifically, your business has to operate in the U.S., make a profit, and meet the SBA’s size requirements. These are just a few of the main requirements. For a detailed list of eligibility requirements, the SBA recommends reaching out to a Certified Development Company in your area.

Use Restrictions

One of the main ways in which business lines of credit and business term loans differ has to do with use restrictions. A business line of credit has no use restrictions, meaning once you’re approved, you can borrow up to the maximum and spend the funds however you see fit.

This isn’t the case with business term loans. Whether you choose a traditional lender, an online lender, or an SBA-backed lender, you’ll have to specify what you intend to do with the borrowed funds, as this is important information lenders need to consider before deciding whether or not to approve the funds you require.

That said, use restrictions are based on the kind of loan you’re looking to secure, as well as the lender you’re looking to borrow from.

For example, if you get an equipment loan, the money must be used to purchase the equipment specified in your business plan. If you don’t use a loan for its intended purpose, you’ll be hit with penalties and required to pay back the borrowed funds immediately.

Use restrictions are especially relevant when you take on an SBA loan. For example, the funds from a 7(a) loan can’t be used to refinance debt, nor can they be used to effect a change in business ownership. Also, 7(a) funds can’t be used to pay delinquent state or federal taxes.

Amount That Can Be Borrowed

In most cases, the borrowing max for a business line of credit is $500,000. With a business term loan, you can borrow millions.

Of course, in either case, the amount you’re allowed to borrow is determined by a range of factors, such as your creditworthiness, your business’ finances, the loan’s purpose, and the likelihood that you’ll be able to make repayments in the future.

If you have good credit, solid business finances, and a clear and well-thought-out loan proposal, you should have no trouble getting the amount you need. But if a lender determines your business is a risky investment, they’ll only extend so much credit.

When it comes to SBA loans, most 7(a) loans have a $5 million borrowing max. 504 loans, on the other hand, have a $5.5 million borrowing max, though you can get up to $16.5 million if you’re undertaking certain energy or manufacturing projects.

Funding Timelines

One of the main reasons why business lines of credit are preferred over other financing solutions is because you can get the money you require in as little as 24 hours. This is especially true if your credit is strong. On the other hand, if your credit isn’t great and your business’ finances look shaky, it may take a few days or even a week to get approved.

Still, the funding timeline for a business line of credit is virtually always shorter than the funding timeline for a business term loan. With loans, you’ll probably have to wait a week or two to get the funds you’ve applied for. In the case of SBA loans, it’s not uncommon to wait as many as 90 days before receiving the funds in your bank account.

Because they allow you to access funding quickly, many businesses get a line of credit when they need to meet working capital expenses or cover unexpected charges.

Interest Rates

Depending on your credit score and a handful of other factors, you could get an interest rate between 3% and 60% on a business line of credit. However, most borrowers secure a rate somewhere between 7.4% and 9.2%.

If you take out a business term loan, you could get a rate between 6% and 12%, especially if you have good credit and solid business finances. If your creditworthiness isn’t great, expect an interest rate closer to 20%.

SBA loans tend to have higher interest rates because they’re generally for businesses with bad credit or limited business history. Therefore, before you apply for one of these loans, know that you could get a fixed interest rate between 13.5% and 16.5%, or a variable rate that maxes out around 15%.

However, one nice thing about SBA loans is they have capped interest rates, meaning they can only go so high. The level at which the interest rate is capped will depend on the kind of loan you’re seeking.

In general, if you’re looking for the more economical financing solution, a bank loan is often the best choice.

Terms

If you get approved for a business line of credit, you’ll probably be able to draw on the funds for 3-5 years. After that time has passed, the lender will review your situation to determine whether or not they want to extend your line for an additional 3-5 years.

Business term loans tend to have longer terms, but the length of your loan’s term is largely determined by its type and purpose. For example, if you get an equipment loan, it’ll probably have a term of 10-20 years. Loans for real estate tend to have a term of 20-30 years, whereas loans for working capital can have a term of a few months to several years.

A longer loan term has pros and cons, of course. Your repayments will be on the smaller side, but you’ll have to pay more in the long run because interest has more time to build up.

Repayment Schedules

How often you’ll have to make repayments is determined by a range of factors. That said, weekly or monthly repayments tend to be the norm with business lines of credit, and the same is true with business term loans.

Basically, if the term is on the shorter side, such as several months or a couple years, weekly repayments are more likely. But if it’s a loan with a decades-long term, monthly repayments are more likely. It’s important to understand what your repayment schedule will be before you sign a loan proposal.

Collateral

In the vast majority of cases, you won’t need collateral to secure a business line of credit. Business term loans, on the other hand, often have to be secured with collateral worth 80%-100% or more of the loan’s value.

There are a variety of assets that can be used as collateral including cash, real estate, vehicles, and a range of other assets. You can check with your bank to see what they allow as collateral when applying.

Even if you don’t have to put up collateral to secure a business term loan, you’ll probably have to sign a personal guarantee, wherein you agree that the lender has the right to seize and sell your collateral if you default. In some cases, you may have to sign a personal guarantee to get a business line of credit, especially if you’re borrowing tens or hundreds of thousands.

Additionally, you’ll have to make a down payment equal to 10%-30% of the loan’s value. Down payments aren’t required with business lines of credit because you don’t get a lump sum all at once, rather you draw on the available amount of credit as you see fit.

Down payments don’t just reduce the risk on the lender’s end; they also show that a borrower is committed to meeting the obligations they’ve agreed to.

Which Type of Financing Is Better for Your Business?

To determine which financing option will be best for your business, you need to list your requirements and goals. Then you must honestly assess your business’ creditworthiness and finances.

If you don’t need to borrow more than $500,000, and you’re looking to get the funds in as little as 24 hours, consider a business line of credit. However, if you don’t have good credit, and your business’ finances have looked shaky recently, drawing on a business line of credit can be quite expensive, especially if you borrow a lot of money and can’t pay it back quickly.

If the speed at which you get funding isn’t a top concern, and you need to borrow over $500,000, consider a business term loan. Especially if you have good credit and solid business finances when you apply, chances are you’ll be able to lock in a low interest rate and flexible lending terms.

Lastly, it’s wise to shop around before you choose a lender. If you don’t, you may miss a fantastic opportunity. Also, when you’re negotiating with lenders, don’t be afraid to mention that you’re considering multiple options.

If you’re ready to secure financing for your business, get in touch with Llama Loan today and let our experts help guide you through the process!

Final Thoughts

Business lines of credit and business term loans are similar in a handful of respects, but they have some differences that can be a deciding factor for which you opt for.

Usually a business line of credit can be secured in 24-48 hours, whereas business term loans take longer to secure (7-14 days). But you can borrow more with a business loan, and the terms tend to be longer and the interest rates lower. However, loans have use restrictions and must be backed by collateral—two things you won’t often have to worry about with a line of credit.