Small Business Loans vs. Business Lines of Credit

What is a small business loan?

A small business loan is a sum of money that you have to repay over a set period of time. There are several types of business loans, and they can come from a different sources, such as traditional banks, credit unions, or digital banks. The Small Business Administration (SBA) also offers loans to businesses that don’t meet the strict requirements of traditional lenders, making them a popular choice for many small business owners. 

Small business loans can range in amounts, sometimes reaching $500,000 or more. Once approved for a loan, you’ll be given the amount of money in a lump sum. You’re then expected to make monthly payments, usually starting immediately after receiving the loan. Repayment terms can range from several months to several years, depending on the size of your loan. During this time, small business loans also incur interest on the full amount. Interest rates on a business loan can vary based on factors such as the lender you choose, your credit score, and how long you’ve been in business. Rates on small business loans can typically range from 4% to 44%.

There are several ways you can choose to use a loan. Small business loans can be used to finance buildings, purchase new equipment, cover operating costs, or other business-related expenses.

What are the pros of a small business loan?

Small business loans are a popular financing option for a reason: they come with several benefits. Some examples of those benefits include:

• Large amounts: Typically, business loans are offered in larger amounts than other financing options. This can be good for businesses that need to be making bigger purchases, such as a new property or larger, more expensive equipment.
• Control: While investors can help with covering business costs, working with one often means you’ll need to give up partial ownership of your business. When taking out a loan, you retain full control over your business. 
• Low interest rates: Loans typically have lower interest rates than lines of credit, though this can vary depending on the type of loan you apply for.

What are the cons of small business loans?

Choosing to take out a loan also has its disadvantages. The downsides of small business loans include:

• Limited flexibility: When you take out a loan, you need to take the full amount up front, even if the full amount isn’t immediately needed. You also have set repayment terms. Business lines of credit are usually more flexible with repayments.
• Risk: Most business loans require you to put up collateral, which will then be lost if you cannot repay the loan in time. This is a risk you’ll need to take on all on your own.
• Strict requirements: If you choose to take out a loan through a traditional bank, you’ll likely face high qualification standards. These standards can include your credit score, your annual revenue, etc. However, if you take out a loan through the SBA, lending qualifications do tend to lessen.

What is a business line of credit?

A business line of credit is a revolving source of credit. It’s similar to a credit card, in that you can borrow and repay as needed. You can obtain a line of credit through financial institutions such as traditional banks, credit unions, or digital banks. 

When opening a business line of credit, you’ll be approved for a set amount of money, which you can borrow from as needed. You will then be expected to repay the amount that you’ve borrowed. Similarly to loans, lines of credit can incur interest overtime, which you’ll also be responsible for paying back.

A line of credit comes with a draw period, which can vary in length. Typically, the draw period for a business line of credit can last up to five years. During this time, you can access the funds, and draw from them as needed. Any funds that you take out will then need to be repaid. Once the draw period ends, you’ll no longer be able to access the funds, and you’ll be expected to pay back any outstanding balances.

What are the pros of a business line of credit?

For some businesses, a line of credit can be a great financing option. Benefits of choosing a business line of credit include:

• Flexibility: With a line of credit, you don’t have to take out the full amount if you don’t need it, and you’ll only have to pay interest on the money you do take out. This kind of flexibility can be useful when having to cover unexpected expenses that come up.
• Easy qualifications: Usually, a business line of credit is easier to qualify for than a business loan, and you probably won’t need to submit as much documentation.

What are the cons of a business line of credit?

Business lines of credit do also come with their own set of disadvantages. These can include:

• High interest rates: Though you don’t have to pay interest on the money you don’t use, the interest you do have to pay can often be higher than the interest rates of a business loan. 
• Budgeting: Since they don’t have a set amount and repayment schedule, lines of credit can often be trickier to budget for. With shorter repayment terms, you may also find yourself needing to make higher payments. 

Bottom Line

Small business loans and business lines of credit are both helpful in getting your business the extra funding it needs. Deciding which option is right for you can depend on different factors, such as the kind of business you operate, the amount of money you need, etc. Make sure you’re fully aware of your options and are making the right decision for your business.