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Businesses that need capital to start or grow their companies at times seek financing. There are two primary types of business financing: 1) a business loan, or 2) a business line of credit.When it comes to a business line of credit vs. a small business loan, there are some key differences that are important to look into—as you weigh the different business financing options out there. Different companies have unique financial needs, so there’s no one-size-fits-all answer to financing a business.
What is a Business Loan?A business loan provides a lump sum of money that approved applicants can use to grow their business. Once a loan is disbursed, borrowers are generally required to make regular payments for a predetermined time—paying back, over time, the amount lent out and the interest that has accrued.A business loan could have a fixed or variable interest rate. A fixed interest rate, as you might guess, is generally unchanging for the term of the loan term. The loan rate and repayment term are identified in the signed loan agreement. For fixed rate loans, the amount charged per payment is—usually locked in—for the life of the loan. It can be a good idea to read lenders’ fine print to review a given loan’s specific terms and conditions.A variable rate, on the other hand, fluctuates based on the overall interest rate in the market. It may start out lower than a fixed rate, which is why variable rates can be appealing to some. Still, with a variable rate, you might also risk the interest rate rising over time, especially when a loan term spans several years.
Types of Business LoansThere are several types of business loans, which is one key difference between the business loan vs. a business line of credit. Typically, business lines of credit are revolving debt—if approved, you’re granted a maximum amount you can withdraw, but you can withdraw it in increments.Interest accrues only on withdrawn funds, and you can keep withdrawing as long as you keep the line of credit open. Funds become available again once they’re paid back . Each type of business financing has its own benefits. Even if you have bad credit, there may be loans you could qualify for— though the interest rates available may be less than competitive.
Bank LoansYou can apply for a loan through a bank or credit union. Typically, bank or credit union loans offer more competitive interest rates than some alternate business loan options. Loans disbursed through a bank or credit union, however, may also be harder to qualify for—as they, generally, require higher credit scores and collateral. Bank or credit union loans can, at times, take longer to process applications than those offered by online lenders.Loans can be secured or unsecured, meaning they either require collateral or don’t. Secured loans may come with more competitive interest rates, since that collateral lowers the lender’s risk. (If a borrower defaults on a secured loan, the lender can put a lien on the collateral or seize it to pay back what’s still owed). Below is a list of the range of loan rates, terms, and amounts offered by three major banks (Bank of America, US Bank, and Wells Fargo)—rates and terms may vary from financial institution to financial institution:
- Rates: 3.5-6.25%
- Loan amount: $5,000-250,000
- Terms: 1-7 years
Small Business Administration LoansAnother loan option is one backed by the U.S. Small Business Administration (SBA), which both banks and online lenders offer. The current SBA loan rates are typically lower than what other loans offer. And, there are a variety of different SBA loan programs for different types of business needs and borrowers. Learn about SBA loans to see if they’re a good fit.
- Rates: 5-6% for fixed rates
- Loan amount: $500 to $5.5 million
- Terms: up to 25 years
Merchant Cash Advance LoansFor businesses who don’t qualify for bank loans or SBA loans, a merchant cash advance could be another option. Often, these lenders look more at your cash flow than your credit score, which typically is expected to be at least in the 500-600 range. They can deliver funds faster than other loans, but they charge a much higher fee.Below are some further details on how Advance Point Capital prices out their merchant cash advances. Different lenders may offer distinct terms, rates and limits for merchant cash advance loans:
What’s the difference between a factor rate and an interest rate? With a factor rate, all of the interest that accumulates on the advance gets charged when the funds are originated.
- Rates: 1.10-1.45 Factor Rate (not an interest rate)
- Fees: 1-3% of loan amount
- Loan amount: up to $500,000
- Terms: 3-24 months
What is a Business Loan?There are various types of business loans that small business owners may opt to compare. Here’s an overview of some pros and cons:
Pros of a Business LoanSo why do some business owners opt to choose a business loan over a line of credit?When a lump sum of money is needed all at once, maybe to cover a real estate purchase or one-time renovation, a loan can give borrowers those funds upfront.Some small business loans come with fixed interest rates, which can make monthly payments more predictable than with variable rate loans. You may also be able to qualify for higher amounts of money with a business loan vs. line of credit.
Cons of a Business LoanOn the other hand, sometimes businesses need a little cash now and a little later. With a loan, you get it all disbursed at once. And, if you need more funds later, it may be hard to qualify if you’re still paying down your old loan.There may also be closing costs that add to what you’re paying for your loan.When it comes to a fixed term loan vs. line of credit, to qualify for the most competitive rates, you’ll likely need higher credit scores or even to provide collateral. Some business owners may not have a high enough credit score or the collateral to be approved for a business loan.
What is a Business Line of Credit?When comparing a business line of credit vs. business loan, the key difference is that with a line of credit, rather than receiving a lump sum of money, you have access to a maximum amount of funds that you can use as you see fit. If you are approved for a $100,000 line of credit and only need $25,000 now, you can take out that lesser amount, then later, when you need another $40,000, you can withdraw more funds.There are some similarities between a line of credit and other forms of revolving debt—such as credit cards. You have a maximum amount you can spend, but you can also make purchases for less than that authorized amount. Interest accrues just on the amount withdrawn. Some lines of credit come with variable interest rates, so it’s a smart idea to read the fine print. Your line of credit activity can be reviewed and, if you’ve made your payments on time, you may qualify for an increase down the road. With a business line of credit, you start paying on your line of credit once you take out money against that line. And, you only pay back what you borrow. The amount available replenishes once you’ve paid it back. So, you may be able to borrow that $100,000 over and over again for the duration of your term—as long as you have paid back what you took out. Business lines of credit, consequently, are generally considered a form of revolving debt–where the approved amount is available again once paid down. There aren’t typically different types of business lines of credit.Here’s an overview of the rates, fees, credit limits and terms from two major US banks (Wells Fargo and U.S. Bank)—these terms and rates may vary at other financial institutions.
- Rates: from 3.75%
- Fees: 0-$150
- Credit line amount: $5,000 to $250,000
- Terms: 3-24 months
Pros of a Business Line of CreditWhen it comes to a business line of credit vs. SBA loan, for example, approved applicants may be able to access funds faster than you would with a lengthy SBA loan application process. Also, a line of credit might be a better fit if a business has fluctuating expenses to cover. Some business owners might just want access to cash to float through a slow season. Others may want to know that there are funds to tap in case of an emergency or sudden expense. Also, being able to borrow just what you need rather than getting more money than you need is a perk of a business line of credit. And, the fact that funding is flexible —with untapped funds available later if needed— could appeal to business owners. Certain lines of credit come with lower interest rates than some business loans.
Cons of a Business Line of CreditThere are drawbacks to lines of credit, though. If you have a project and know you need a large amount of cash, a line of credit might not offer you enough capital. They typically have shorter repayment terms, which can eat a large chunk of your monthly expenses as you pay back what you’ve borrowed.And, lines of credit may have variable interest rates. Variable interest rates could mean you may end up paying more some months in interest than others.
Exploring Business Loan OptionsThere’s no easy answer as to whether a line of credit or loan is best for your business needs. Start asking yourself questions to find your answer:
Even once you’ve done your research and gathered all the business loan and business line of credit information you can find, you’ll then need to determine which lender you want to work with. Requirements to qualify will vary from one lender to another, as will rates, terms, and amounts you can borrow.
- How much money do I need? (Loans may be a better choice if a large sum is needed.)
- What will I use the money for? (Business loans generally come with restrictions attached to what the funds can be spent on.)
- Do I need it all at once, or spread out over time? (A loan amount can be disbursed as a lump sum and a line of credit tapped into only when needed.)
- How much can I afford to pay in loan payments each month? (A line of credit could require fewer payments, if only some of the approved financing gets withdrawn.)
- How fast do I need the financed money? (If you need access to funds at different times, a line of credit may offer more financing flexibility—as it can be tapped when needed.)
- What financing options do I qualify for? (If you’re not certain whether you qualify for a business loan or line of credit, you can research different lenders' requirements to get a clearer idea of the various factors they weigh.)
Business Financing that Suits Your BusinessBoth business lines of credit and business loans can assist with maintaining cash flow and having reserves when it’s time to to grow or even out your revenues. Spend time comparing business lenders, both traditional and online, to find the option that is most affordable and suits your current business needs.
The information and analysis provided through hyperlinks to third party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.Disclaimer: Many factors affect your credit scores and the interest rates you may receive. SoFi is not a Credit Repair Organization as defined under federal or state law, including the Credit Repair Organizations Act. SoFi does not provide “credit repair” services or advice or assistance regarding “rebuilding” or “improving” your credit record, credit history, or credit rating. For details, see the FTC’s website on credit (https://www.consumer.ftc.gov/topics/credit-and-loans)
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About the Author
Susan Guillory is the President of Egg Marketing, a content marketing firm based in San Diego. She’s written several business books, and has been published on sites including Forbes, AllBusiness, and Cision. She enjoys writing about business and personal credit, financial strategies, loans, and credit cards. Follow her on Twitter @eggmarketing.