Business line of credit vs. business loan: How to decide
Small-business owners (SBOs) have many choices when looking to raise capital for their operation. Two common options are business lines of credit and business loans.
Lines of credit are often used to maintain flexible on-hand capital, while loans are typically used to fund larger purchases. Each option differs in how funds are disbursed, how interest is charged and how repayment is structured. Keep reading to learn more about the differences between business lines of credit and business loans—and how to decide which is right for your business.
What you’ll learn:
- A business line of credit is a flexible form of revolving credit that allows you to borrow funds as needed and repay them as you use them.
- A business loan is a lump sum of cash, often used for a specific purpose, that you borrow and repay over time with interest.
- To decide which funding source is right for your business, consider factors such as how much funding you need, what you plan to use it for and your business’s track record.
What is a business line of credit?
A business line of credit is a form of revolving credit with a set credit limit. A business can borrow up to that limit and reuse the funds as it pays down the balance—similar to a credit card. The lender typically charges interest only on the borrowed funds, not the full credit limit.
When a financial institution issues a business line of credit, business owners can typically access their available funds online. Each draw from the line of credit accrues interest, and repayment is based on the outstanding balance. Business owners often need to repay what they borrow within a relatively short time frame, although long-term lines of credit may be available.
Businesses often use a line of credit for purposes such as managing cash flow, covering operating expenses or emergency needs, and purchasing equipment or inventory.
Types of business lines of credit
Business lines of credit generally fall into one of two categories: secured or unsecured. Here’s how each works:
- A secured line of credit requires collateral to help assure the lender that the borrower can repay the balance if the borrower defaults on payments. Acceptable assets to use as collateral often include cash, real estate and investments. Secured lines of credit typically offer higher credit limits, lower interest rates and longer repayment terms than unsecured lines of credit.
- An unsecured line of credit doesn’t require collateral, but it may require a personal guarantee, which can make the business owner personally liable for amounts the business is unable to repay. Unsecured lines of credit generally feature lower credit limits, higher interest rates and shorter repayment terms.
What is a business loan?
A business loan is typically a one-time lump-sum payment that a business borrows from a financial institution. The business then repays the loan, along with interest and any applicable fees, over a set period of time. Business loans can be secured or unsecured and have a fixed or variable interest rate.
Upon approval of a business loan, a lender typically issues the full loan amount to the business all at once. Depending on the type of loan, the repayment period may range from as short as six months to as long as 25 years. Businesses may use loans to hire employees, increase working capital or purchase real estate.
Types of business loans
Here’s a breakdown of the main types of business loans:
- A term loan is a lump-sum loan that businesses must repay over a set period of time, often with a fixed interest rate. This common loan type can be more affordable than some other options, but it can be harder to qualify for favorable terms. A term loan also may require collateral or a personal guarantee.
- An SBA loan is offered by financial institutions and partially guaranteed by the U.S. Small Business Administration (SBA). SBA loans come in different forms and may be used for a number of purposes. Among them are working capital and real estate purchases. SBA loans can be harder to qualify for but may offer larger loan amounts and lower interest rates than some other loan options.
- A microloan is a type of small-dollar business loan that generally offers amounts of up to $50,000. These loans can be easier to qualify for, making them a viable option for newer businesses or those with lower credit scores. Some microloans are backed by the SBA.
- An equipment loan is a targeted small-business loan used to finance purchases of equipment, like vehicles or machinery. The equipment can be used as collateral, which can make this loan type easier to qualify for.
- A commercial real estate (CRE) loan is used to finance the purchase of commercial property. Interest rates are generally higher on CRE loans than on residential mortgages, though business owners may be able to secure a lower rate with an SBA-backed CRE loan. Repayment terms can last up to 20 years in some cases.
Differences between business lines of credit and business loans
Business lines of credit and business loans are both common financing options for SBOs. Here are some of the primary differences between the two:
| Business line of credit | Business loan | |
| Loan amount | Generally smaller | Generally larger |
| Possible uses | Often flexible and can be used for various business needs | Often used for a specific purpose as outlined in the loan application |
| Repayment terms | Revolving credit repaid as funds are used, often with shorter repayment time frames | One-time lump sum repaid in regular installments over a few months or a longer period, possibly extending up to 25 years |
| Interest rates | Can be higher, but interest is only charged on borrowed funds | Can be lower, but interest is charged on the full loan amount |
| Eligibility requirements | Generally easier to qualify for; may require a personal guarantee | Generally harder to qualify for; may require collateral |
Loan amount
Business lines of credit are available in a variety of amounts, often ranging from as little as $5,000 to as much as $500,000. Higher credit scores and secured lines of credit may allow for larger limits, with some lenders offering significantly higher limits.
Business loan amounts are higher on average, with SBA-backed offerings typically ranging from $500 to $5.5 million, depending on the loan program.
Possible uses
Business owners may use lines of credit for various business needs, offering more flexibility than many traditional loans.
Business loans can be more restrictive. Some loan types are intended for a specific purpose, such as equipment or real estate purchases. Funds from these targeted loans may be limited to those uses.
Repayment terms
Business lines of credit are a form of revolving credit, meaning borrowers repay interest and fees on the amount they use. As the balance is repaid, that amount becomes available to borrow again. Payments are typically due weekly or monthly. Repayment terms typically range from six to 24 months for short-term lines of credit, and they may extend up to five years or even longer for long-term options.
Lenders issue business loans as a lump sum, which borrowers repay in regular—often monthly—installments that include principal, interest and any applicable fees. Repayment periods can range from a few months to as long as 25 years, depending on the type of loan.
Interest rates
With a business line of credit, business owners typically pay interest only on the amount they borrow, starting when funds are drawn from the credit line. Interest rates can vary significantly, depending on the lender, the borrower’s credit profile and whether the line of credit is secured.
Business loans may feature fixed or variable interest rates. A fixed interest rate means monthly payments generally remain the same, while a variable interest rate can fluctuate based on market conditions. The interest rate associated with a business loan depends on factors such as the lender, loan amount and credit profile, with higher credit scores often allowing for lower interest rates.
Eligibility requirements
Business lines of credit often have more flexible eligibility requirements, with lenders commonly considering factors such as credit profile, time in business and revenue. Secured lines of credit may require collateral and, in some cases, a personal guarantee.
Business loans often have stricter eligibility requirements and generally require good credit, a longer business track record, and collateral or a personal guarantee. Business owners may also need to demonstrate how they intend to use and repay the loan.
Should I get a business line of credit or a business loan?
To decide whether a business line of credit or a business loan is right for you, here are some guiding questions you can ask yourself to get started:
- How much money do I need? If you need a larger sum, a business loan may be a better fit for your financial goals, as loans generally offer higher borrowing amounts.
- What do I need funding for? If you need flexible funding on hand, a business line of credit can help increase working capital. If you need funding for a specific purpose, like a major purchase, a business loan may be better suited.
- What is my business’s financial situation? Newer businesses or those with lower credit scores may have a harder time qualifying for a business loan, which can make a line of credit a more accessible option.
Key takeaways
Weighing your funding options as an SBO starts with understanding your financial health and setting clear goals. Lines of credit and loans can be great ways to cover business expenses, but they aren’t the only options available. The right option for your business will depend on how much flexibility you need, how quickly you need funds and how you plan to repay what you borrow.
Another way to meet your business’s financing needs is with a Capital One business credit card. You can check on your pre-approval status before applying—with no impact on your credit scores.
