Editorial · June 25, 2019
Business Line of Credit: How It Differs From a Loan
A business line of credit is a set amount of money a lender agrees to let you borrow from over time, and a term loan is a single sum you repay on a fixed schedule. That is the whole difference in one line. The rest of this guide shows how each one works, what each one costs and when each one fits.
How a business line of credit works
A lender looks at your business and agrees to a credit limit. You do not get the money all at once. You draw only what you need, when you need it. As you pay the balance down, that room opens up again, and you can borrow again. This is why it is called revolving credit.
A lender checks your financial statements before it sets the limit. After that, you usually do not have to apply again each time you draw. The approval is already in place. That makes a line handy when a bill lands on short notice.
Interest is charged on the money you have drawn, not on the whole limit. A lender may also charge a commitment fee for keeping the line open. Many lines carry a variable rate, which means your cost can change over time. Payments on a revolving line often cover only the interest and any fees until you choose to pay down the balance.
How a term loan works
A term loan pays out one lump sum on day one. You repay it in a fixed number of payments over a set period. Each payment covers some of the loan and some of the interest. When the last payment is made, the loan is over. If you need more money later, you apply again.
Because the schedule is fixed, a term loan is easy to plan around. You know what you owe each month and when it ends. The trade-off is that you pay interest on the full amount from the start, even if you do not spend it all right away.
One common view is that revolving credit tends to cost more per dollar than a plain installment loan, because you are paying for flexibility. Rates differ by lender and by borrower, so compare real offers rather than rules of thumb.
Side by side
- Money: A line gives you access up to a limit. A term loan gives you the full amount at once.
- Interest: On a line, you pay on what you draw. On a term loan, you pay on the whole balance.
- Repayment: A line refills as you repay. A term loan is paid off on a schedule and then closes.
- Best for: A line suits uneven cash flow and surprise costs. A term loan suits a single large purchase with a known price.
- Rate: A line often has a variable rate. A term loan often has a fixed one, though both vary by lender.
When each one fits
Match the tool to the need. If the cost is a one-time purchase, such as equipment or a vehicle, a term loan is the cleaner fit. You know the price, and you can spread it over the life of the asset.
If the need keeps coming back, a line of credit is often the better fit. Think of a shop that buys stock before a busy season and gets paid weeks later. Or a firm that waits 45 days for a customer to pay an invoice but must meet payroll every two weeks. A line covers the gap, and you pay it back when the cash arrives.
A line is not free money for long-term bets. If you draw on it to fund something that will take years to pay back, you may carry a balance for a long time at a variable rate. Keep long-term needs with long-term loans.
What owners actually apply for
The Federal Reserve Banks ran a survey of small employer firms in the second half of 2018 and published the results in April 2019. Of the firms that applied for financing, 85 percent sought a loan or a line of credit. Among those applying for a loan or line, 53 percent asked for a business loan and 42 percent asked for a business line of credit.
Approval rates were close. Among applicants for a business line of credit, 73 percent were approved for at least some credit. For a business loan, the figure was 67 percent. For an SBA loan or line of credit, it was 52 percent. These are survey results from one period, so treat them as a snapshot and not a promise.
Lines are also common once a firm is in place. Among firms that did not apply in the past year but held some type of loan or line, 41 percent reported a business line of credit.
A government-backed option: SBA CAPLines
The U.S. Small Business Administration backs a group of lines under a program called CAPLines. The agency describes the program as help for small firms with short-term and cyclical working capital needs. The SBA does not lend the money itself. Banks and other lenders do, and the agency guarantees part of the loan.
CAPLines has four parts. A Contract line finances the material, labor and overhead for a specific contract. A Seasonal line supports the build-up of inventory, receivables or labor above normal levels. A Builders line helps small contractors build or rehab property. A Working Capital line is a revolving line that provides short-term working capital.
Ask a lender which of these suits your case, and what terms and fees apply to it. Government-backed credit comes with its own paperwork, and the survey above shows approval rates for SBA credit ran lower than for other products.
Questions to ask before you sign
- What is the credit limit, and can the lender lower it later?
- Is the rate fixed or variable, and what moves it?
- Are there fees to open the line, keep it open or draw from it?
- Do you need to put up business assets as collateral?
- Do you have to repay the balance in full at some point, or does the line renew?
Write the answers down and compare at least two lenders. A line of credit is a tool, and the right one depends on whether your need is steady, sudden or one-time.