Line of Credit vs Business Loan: Which Is Right for You?
Before you apply for a business loan or a line of credit, it’s important to understand the pros and cons of each so you can choose the right type of funding for your unique situation.
I’ve used both lines of credit and small business loans in my own small business, so I can help you understand all the ins and outs. Whether you’re a complete novice about business financing or you’ve looked into these options before, I share some helpful tips and things I learned along the way.
What Is a Business Loan?
A business loan is a type of funding that enables businesses to receive a lump sum of money that must be paid back over time, including the principal and interest. Unlike a credit card or a line of credit, a business loan is not revolving credit where you can use the funds again and again. You just get the funds upfront and then begin making monthly payments from there.
Business loans are one of the most versatile types of funding that you have access to as a business owner. Not only do you have the ability to borrow millions of dollars, but there are different types of business loans designed specifically for certain purposes. Some of the most common types of business loans include:
- Standard Term Loans: The common business loan typically requires you to put up collateral against the loan if the amount is large enough.
- Small Business Administration (SBA) Loans: A federal loan guarantee program that helps small and medium-sized businesses obtain funding.
- Equipment Loans: Business financing specifically for procuring equipment that you need for your business.
- Commercial Real Estate (CRE) Loans: One of the largest business loans available, where a business puts up its own commercial properties as collateral to potentially get millions to take advantage of an opportunity or make a major acquisition.
- Unsecured Loans: A business loan in which your business does not need to offer collateral against the loan. The limits on these loans are typically much lower.
- Business Acquisition Loans: A loan that you can use to buy a business, buy out a partner, or expand a franchise.
As you can see from the above options, different types of business loans can be used for all kinds of purposes. While in theory you could get a term loan and use it for just about any business expense you want, you can typically get better rates and terms if you get a loan designed for the specific purpose that you’re using it for.
Depending on the size of your business, and many other factors, the sum of a business loan can be as little as $500 up to $10 million or more. Interest rates can range from around 4% to 35% and terms can be as little as 3 months or as much as 25 years.
How Do You Get a Business Loan?
Applying for a business loan can be done in person at most banks or online using direct online lenders or online loan marketplaces. Through my experience as a business owner, online applications are significantly easier than going to the bank in person, and you can typically get better terms online.
Using either direct lenders such as Biz2Credit or Rapid Finance or a loan marketplace like LendingTree, the online application process for a business loan is fairly standard. There might be some small differences between lenders depending on which company you use, but for almost any of them you’ll need to provide the following information when you apply for a business loan:
- Personal information (name, address, etc.)
- Proof of identity (driver’s license or other government-issued ID)
- Business information (name, address, type of business, etc.)
- 3+ months of bank statements
- Business and personal tax returns
- Credit account statements
- Balance sheet
- Profit/loss statement
Once you provide this information, the lenders will be able to present you with options, either online or over the phone. In either case, the application process shouldn’t take you more than 10 minutes once you have all of your documents uploaded and ready to go.
Business Loan Pros and Cons
- Designated loan types that come with lower interest rates
- Predictable monthly payments with a final repayment date
- Potentially borrow millions of dollars
- Enables you to get cash without sacrificing any equity in your business
- Non-revolving credit so you don’t constantly have access to more cash
- Some lenders will require a high credit score (650+) and for you to have been in business at least 18 months
- Less flexibility on what you can spend the money on
What Is a Line of Credit?
A line of credit is a lot like a credit card in the sense that as a business owner, you’re able to borrow up to a set amount. Any amount that you use from the line of credit, you owe back and have to start making monthly payments that include paying back the principal as well as paying interest.
Similar to credit cards that you may have for the business or yourself, any balance that is not paid off at the end of the month begins to accrue interest. But at the same time, you can continue to draw more funds from the line of credit up to the maximum limit (known as the credit limit). This type of credit is known as revolving credit since you can keep using it again and again.
Lines of credit are typically used by businesses when they need short-term financing such as boosting inventory or hiring seasonal employees. Having a line of credit is also a great idea for a business that doesn’t have enough cash reserves yet but wants to have an emergency fund. Since the funds can be drawn at your discretion and used how you please, it’s perfect for a sudden expense.
In most cases, lines of credit will max out around $250,000 depending on where you go for the credit. The terms on lines of credit typically include interest rates (ranging anywhere from 4.80% – 25%) which will be affected by your credit score(s), how much you draw from the credit, if you miss any payments, and more.
How Do You Get a Line of Credit?
Lines of credit are typically offered from banks, direct online lenders, and online loan/lender marketplaces. Some of the top online lenders that you should keep in mind if you’re interested in a line of credit for your business include LendingTree, Rapid Finance, and Biz2Credit.
Applying for a line of credit online is quicker and easier than going into a brick-and-mortar bank, and you can potentially see offers in minutes. Most online lenders will ask for some information about yourself as well as your business to see what lines of credit they can offer you and boast an application process that’s entirely online.
While any single lender may have some additional requirements, you’ll need to provide the following at a minimum:
- Personal information (name, address, phone number, email)
- 3-6 months of bank statements
- Identification verification (driver’s license, other ID)
- Business information (name, address, etc.)
- Balance sheet
- Profit/Loss statement
- Business & personal tax returns
Lenders will use this information to verify you as the business owner and check your business’s annual revenue, how much cash you have on hand, and more. In addition to this information, many lenders will require your business to meet some minimum thresholds as well. Some examples of what some lenders require before offering a line of credit include:
- Minimum credit score of 580+
- 6-18 months in business
- $100,000 to $250,000 in annual revenue
- Collateral to put up against the loan
Depending on which lender you go with, you might see offers right away or you might need to wait a few days before you hear from a representative about what they’ll be able to offer you.
Line of Credit Pros and Cons
- Revolving credit so you can use the funds as you need to
- Easily accessible cash for emergency situations
- No money is due if you don’t draw any funds
- Can help you build your business’ credit score as you use the funds and pay it off
- Typically limited to around $250,000
- Significantly higher interest rates if you have a low credit score
- May need to provide collateral to qualify
Which Is the Best Type of Funding for Your Business?
Deciding between a business loan and a line of credit really comes down to how much money you need, what you need the money for, and what type of repayment terms you want to have. If you need fast cash to cover short-term expenses or you want to have access to emergency funds if something unexpected comes up, then a line of credit might be better for you.
But if you need more than $250,000 to make an acquisition or take advantage of an opportunity, a business loan is the better option. Business loans might also be better if you have a specific purpose in mind for the funds since you can likely find better rates on a specific type of loan.