Small-Business Loan vs. Line of Credit

t’s hard to grow a small business when you’re operating on a limited budget. Business loans and lines of credit can both provide funding for your business. Choosing whether you should get a business loan or a line of credit will depend on factors such as what you need the money for and how quickly you need to access it.

Unique financial needs of small businesses

Small businesses are the backbone of the economy, making up more than 99.9% of all businesses in the U.S. They often face financial challenges that large corporations don’t have to deal with, such as using personal funds to cover shortfalls and having enough cash on hand to cover operating expenses. Because of these challenges, financing options can play an outsize role in the success of any small business. Two of the most popular funding sources include loans and lines of credit.

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What is a small-business loan?

A small-business loan is a lump sum of money that you have to repay over a set period of time, usually with interest. There are many different types of business loans. Some require collateral, but others are unsecured. Lenders typically offer business loans in amounts up to $500,000 or more, with repayment terms ranging from several months to 25 years. Business loans are similarly versatile in their uses. You can use them to finance buildings or equipment, cover operating costs, purchase inventory, or cover other business-related expenses.

You can get a business loan from a traditional bank, a credit union, or a digital bank. The Small Business Administration (SBA) guarantees some business loans in the U.S., which may help you secure financing if you don’t meet the strict requirements of traditional lenders. However, not all small-business loans are guaranteed by the SBA.

After you’re approved for a business loan, you’ll be given the amount in a lump sum. You’ll usually start making monthly payments immediately, and you’ll pay interest on the full amount. Interest rates on business loans vary widely based on factors such as your credit score, how long you’ve been in business, and the lender you choose. Rates can range from 4% to 44%, and you may have to pay a loan origination fee as well.

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Benefits of a small-business loan

Business loans offer numerous benefits, which is one reason they’re popular funding options. Some of the benefits include the following.

Larger amounts

Business loans are usually available in larger amounts than business lines of credit. If you need to buy property, purchase expensive equipment, or fund a new startup or location, a business loan will usually give you access to more money.

Increased control

Particularly if you’re starting a new business, a loan can eliminate the need to take on investors. While investors can help you cover your expenses, you’ll likely have to give up partial ownership of your company in exchange. If you take out a loan instead, you can retain total control and ownership of your business.

Lower interest rates

As a general rule, loans have lower interest rates than lines of credit. However, this will depend on the type of loan you qualify for, so read the terms and conditions closely.

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Downsides of a small-business loan

A small-business loan isn’t always the best option. It can have some downsides, including the following.

Less flexibility

With a business loan, you have to take the entire amount up front, even if you don’t need it all at once. Your repayment terms are also fixed. Lines of credit usually offer more flexible repayment terms.

More risk

If you put up collateral to secure a small-business loan, you’ll lose it if you can’t repay the loan. With a loan, you don’t have to share any of the ownership or proceeds with investors. However, you also have to take on all of the risk yourself.

Strict qualification requirements

Business loans, especially traditional bank loans, often have higher qualification requirements than lines of credit. You’ll usually need to meet higher standards in the following areas:

• Credit score
• Time in business
• Annual revenue
• Documentation

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What is a business line of credit?

A business line of credit is similar to a credit card in that it’s a revolving source of credit. You’re approved for a set amount and can borrow against it as needed. You have to repay and pay interest on only the amount you’ve actually borrowed.

You can obtain a business line of credit from the same sources you use to get a business loan, including traditional banks, credit unions, and digital banks. With a line of credit, you’ll have a draw period, during which you can access the funds. This period can be up to five years, and you can repeatedly draw on your funds as you pay them back. After your draw period ends, you won’t be able to access any additional funds, and you’ll need to pay back the outstanding balance.

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Benefits of a business line of credit

A business line of credit can be a great option in the right circumstances. Some of the benefits include the following.

Flexibility

You can use a business line of credit for almost any business-related expense, and you don’t have to tell the lender how you plan to use it. You can use a line of credit to cover operating costs during a tight month, to cover unexpected expenses that come up, or to take advantage of a growth opportunity. On the flip side, you don’t have to use the whole amount if you don’t need it. You’ll pay interest only on the amount you borrow.

Easier qualifications

It’s usually easier to qualify for a business line of credit than for a traditional business loan. Most lenders have lower credit-score, revenue, and time-in-business requirements for business lines of credit. Additionally, you probably won’t have to submit as much documentation for a line of credit as you would for a loan.

Pay only for what you use

With a business line of credit, you’re not obligated to use the entire amount you’re approved for. If you apply for $50,000 but need only $20,000, you’ll have to repay—and pay interest on—only the $20,000. Although your interest rate may be higher, you don’t have to pay interest on any of the money you don’t need, so you could save in the long run.

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Downsides of a business line of credit

As with business loans, there are drawbacks to business lines of credit. The biggest cons include the following.

Higher interest rates

Although you don’t have to pay interest on the money you don’t use, the interest rate on the money you do use will probably be higher. In some cases, the interest rate can be considerably higher.

More difficult to budget

Without a set repayment schedule and amount, it can be more difficult to budget with a business line of credit. Your payments may also be higher since the repayment terms are usually shorter.

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Takeaways

Deciding on a small-business loan vs. a line of credit comes down to the needs of your business. A small-business loan may be better if you need to borrow a larger amount or you need to finance a fixed expense. You might choose a line of credit if you need more flexibility for unexpected expenses.

Novo Funding is another flexible option for financing your business. You can access up to $75,000 in fast capital to help your business reach its potential. Apply today to get started.

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