Before you take out a small business loan, you should know how installment loans are different from revolving lines of credit.

In this article, we’ll discuss these differences, how each kind of financing works, and the advantages of both so you can easily determine which is better for your small business.

Key Takeaways

• Small business loans are installment loans. This means the borrower has to make minimum repayments on a schedule until the loan is paid off.
• A business line of credit, on the other hand, is an example of revolving credit. In this case, the borrower can draw from their line so long as there’s available credit.

Is a Small Business Loan Installment or Revolving?

A conventional small business term loan is an installment loan, meaning you have to make repayments on a schedule until the principal plus interest is paid off. Depending on the loan’s type, size, and other factors, you could have to make repayments on a weekly, bi-weekly, or monthly basis.

Regarding the size of repayments, your lender will determine a minimum amount that has to be paid consistently, but you can make repayments that are larger than the minimum. For example, some borrowers like to pay the minimum plus interest to ensure their balance is always shrinking.

Business lines of credit and business credit cards, which are considered loans by many, are examples of revolving credit. The term revolving refers to the fact that your balance is likely to go up and down while you have access to the credit line.

For example, say you have a $20,000 business line of credit. First, you purchase a $5,000 piece of equipment for your business, leaving $15,000 in available credit. Then, over the next few months, you pay back a portion of the borrowed $5,000, thus increasing your available credit.

Essentially, with revolving credit, you can draw on the line so long as you have available credit. A conventional small business term loan doesn’t work like this. With a loan, the money you get up front is all you have access to. Once it’s spent, it doesn’t get replenished in proportion with repayments you’ve made. You’d need to get another loan in order to secure more funds.

Can a Business Line of Credit Turn into an Installment Loan?

Yes, but this only happens if you don’t pay back what you’ve borrowed before the term of your credit line ends. Basically, if you have a five-year business line of credit, and $2,000 still needs to be paid back at the end of year five, the remaining $2,000 will be converted into a term loan that must be paid back with regular installments over a certain period.

How Does an Installment Loan Work?

Installment loans are used all the time for different reasons. Mortgages, car loans, student loans, and business term loans are all examples of installment loans. One of the main reasons why they’re so common is they’re incredibly straightforward and simple to understand. Essentially, you borrow a sum of money and then pay installments (repayments) until the principal plus interest is paid off.

The size of installments is determined by the loan’s type, its term, your creditworthiness, and a few other factors. It’s possible to pay a loan back before the term is up, by making sizable repayments, but by doing so you might incur a prepayment penalty that amounts to 1%-5% of the loan’s value.You can always check with your lender to see if prepayment penalties apply to your financing.

You can get an installment loan from a traditional lender, like a bank or credit union, or you can get one through an online lender. Additionally, you can get an installment loan from a lender that’s backed by the Small Business Administration (SBA).

To secure a conventional small business installment loan, you’ll need to have decent credit, acceptable business finances, and a feasible plan for how you’ll pay back the money.

Every installment loan has two parts: the principal and the interest. The principal is the initial sum you borrow, while the interest is essentially a charge you pay every billing cycle until the loan is paid off. Interest is always a percentage of your outstanding loan balance, which means how much you pay in interest each billing cycle shrinks as your outstanding balance shrinks.

For example, if you take out a $20,000 small business installment loan with a 10-year term and a 6% interest rate, you’ll pay back $26,644.92 if you make $222.04 repayments every month for ten years.

If you default on an installment loan, your lender will seize and sell the collateral you put up to secure the loan to offset their loss. If your collateral doesn’t completely cover what’s owed, you’ll have to pay back the remaining balance over time.

How Does a Revolving Line of Credit Work?

Most of the lenders that offer conventional small business installment loans offer revolving credit as well, namely business lines of credit and business credit cards. Revolving lines of credit are like conventional installment loans in many respects, but it’s the ways in which they’re different that lead borrowers to choose one over the other.

For example, a revolving line of credit can be used until the term is up, so long as you don’t reach your credit limit. Essentially, you can draw on a line of credit as you see fit and pay back what you’ve borrowed to make more credit available.

Let’s say you have a $50,000 line of credit. If you spend $20,000 and pay back $10,000, you’ll be able to borrow up to $40,000.

But once you rack up a balance, you’ll have to make at least minimum payments on a schedule until the balance is paid off—just like you’d do with a conventional installment loan. Also, the amount you don’t pay back right away will be subject to interest. Again, what you pay in interest will be a percentage of the outstanding balance.

Many businesses like revolving credit because it gives them quick access to funds when unexpected expenses pop up. Of course, there are some important points to consider before getting a line of revolving credit.

For example, lines of revolving credit are subject to higher interest rates, and the terms are shorter. But just because a business line of credit has a five-year term doesn’t mean you won’t be able to renew it after five years.

Advantages of an Installment Loan

Lower Interest Rates

Installment loans tend to have lower interest rates than business lines of credit and business credit cards. In general, the average interest rate on an installment loan is about 9%, whereas ~25% is the average interest rate for a business line of credit and ~30% is the average interest rate for a business credit card.

Of course, what you get as an interest rate is determined by your creditworthiness and a range of other factors. However, if you have stellar credit and solid business finances, the interest rate you get should be at the lower end of the range.

Most lenders consider a personal credit score of 740 or higher as very good; a business credit score of 80 is also considered very good.

A lower interest rate means it’ll be cheaper to borrow, whether you’re using an installment loan, a business line of credit, or a business credit card.

Larger Loan Size

With a conventional installment loan, you can borrow much more than you’d be able to borrow with a business line of credit. Essentially, you can borrow hundreds of thousands or millions of dollars with an installment loan, whereas $500,000 is often the max you can borrow with a business line of credit.

This means that an installment loan will probably be your best option if you’re looking to purchase or develop commercial real estate. However, the more you borrow, the more you’ll have to pay back in the long run, especially if you get a loan with a high interest rate.

Longer Terms

Conventional installment loans generally have longer terms than business lines of credit and business credit cards. That said, you can get an installment loan with a term that’s shorter than the average business line of credit term.

For example, if you get an installment loan that’s expressly for purchasing real estate or business equipment, expect the loan’s term to be between 10 and 30 years.

Additionally, when it comes to terms, business lines of credit are different from installment loans, in that once your credit line’s term ends, it’s up to the lender whether or not to extend the line again. Also, you’ll only have a certain amount of time to draw on your line of revolving credit.

Easier to Keep Up With

Many borrowers find that installment loans are easier to keep up with because you have to pay a fixed amount every week, two weeks, or month. With revolving credit, your minimum payment goes up in proportion with how much credit you’ve used.

Also, you may forget about purchases made with a line of credit or business credit card, and if you forget to make a repayment you’ll be saddled with a late-payment fee. It’s harder to forget about installment loan repayments because you have to make them whether you’ve spent the money or not.

Advantages of a Revolving Line of Credit

Easier to Get

Revolving credit is generally easier to get than an installment loan. All you need is decent credit and acceptable business finances. The lender will calculate the level of risk you pose to determine how much credit they’re willing to extend.

But if you secure a line of credit with bad credit and shaky business finances, in all likelihood you’ll be saddled with a high interest rate and stricter lending terms.

Of course, the ease at which you get credit depends on the lender you choose. That said, you shouldn’t have a hard time getting approved if you can meet the lender’s basic requirements.

Quick Access to Funds

One of the most appealing aspects of revolving credit, specifically business lines of credit, is you can get funding in as little as 24 hours. This isn’t the case with installment loans, as it usually takes 1-2 weeks to secure one. This is one of the main reasons why business lines of credit are preferred by businesses that need to cover unexpected charges quickly.

Of course, the time it takes you to get a business line of credit largely depends on your business’ creditworthiness, its finances, and the lender you choose. That said, if you have good credit and attractive business finances, it shouldn’t take you long at all to get approved for the line of revolving credit you’re looking for.

No Use Restrictions

Unlike installment loans, revolving lines of credit don’t have use restrictions. Therefore, once you secure a line of credit, you can use the available credit how you see fit. With an installment loan, you’re limited to spending on what the loan was approved for.

This is why revolving lines of credit are great for businesses that need a boost in working capital. However, you won’t be able to use a credit line to pay off debt.

Cheaper

With revolving credit, you only borrow what you need, which means you won’t have to pay as much in interest if you use a lesser amount. With an installment loan, sizable interest gets tacked on to your balance right away, and only after you start making repayments does the interest get smaller.

So, if you’re looking to make relatively inexpensive purchases that can be paid off quickly, consider revolving credit.

Final Thoughts

Small business loans are paid back in installments. An installment is a fixed amount that’s paid regularly over the loan’s term until there’s no longer a balance.

Revolving credit is different in that you can draw on your credit line until you’ve reached your credit limit. Also, making repayments on borrowed money allows you to re-borrow in proportion with what you’ve paid back.