Business owners have several choices when it comes to financing their expenses. The most popular choices are business loans and lines of credit. Whether a business loan or line of credit is more advantageous will depend on what you will use the funds for.

Revolving Funds vs. One-Time Loan

When your business loan gets approved, you will get the total amount for the loan and then make scheduled repayments for that amount. This gives you complete access to the funds and allows you to use them for whatever your business needs.

Although it also gives you access to funds, a line of credit is different from a loan. When you apply for a line of credit, you want to access revolving funds. This is comparable to credit cards or home equity lines of credit. You are allowed to borrow a specific amount of money. You can withdraw only the amount you need or get all the funds upfront.

Business loans provide one-time access to funding. Lines of credit are sources of funds that you can use given that you have available credit. When you repay your debt on your credit line, the available credit will be replenished.

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Loan Structure

For business loans, the repayment schedule is usually set monthly. You will be required to start payments within 30 days until the loan is paid in full. The loan payment amount does not change even if your loan balance decreases.

If you choose a line of credit, you only need to pay the outstanding balance instead of having a fixed amount monthly. So your total payment monthly will vary depending on the amount that you borrow. The line of credit may require monthly payments on the interest. Other lenders will require you to pay a specific principal amount plus interest. Your monthly payments can increase or decrease when you pay your outstanding balance or as use up more credit.

Loan Terms

Business loans are also called term loans because you need to pay the amount over a prearranged length of time. This can last up to 20 years depending on the terms of the loan.

Repayment for a line of credit is not based on a set term but on the balance that you owe. If your lender requires you to pay 2% of your outstanding balance every month and you borrowed $5,000, you will need to pay $100 per month. if you withdraw another $5,000 from your line, your balance is now $10,000 and your monthly payment will be $200.

Business loans typically have higher monthly payments than lines of credit. You would need to pay off the loan in a comparatively shorter period.

Loan Fees

Business loans and lines of credit have different fees. A business loan will usually have some upfront fees such as an origination fee. This fee is a percentage of your business loan amount and can be from 1 to 6 percent of the total amount.

A line of credit doesn’t usually have origination fees because it’s a credit line and not a fixed loan. However, there can be draw charges every time you withdraw from the line. The draw fee is a fixed amount. If you draw from your credit five times within the year, you would pay $250 on charges.

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Loan Purposes

Now let’s look at the purposes of each type of loan so you can determine which type works best for you. It all depends on what you are going to do with the funds. A business loan is recommended if you need funding for long-term capital expenses such as business equipment. Equipment will last several years so you can match your loan term to the expected number of productive years for that specific asset. By doing so, you can avoid out-of-pocket expenses for your equipment. You can also spread the original cost over a number of years.

Lines of credit are more advantageous for those who need working capital. You can use this to cover short-term operating costs such as payroll, inventory, or a huge expense that you expect in the future. A line of credit can also become an extra source of funds to cover these costs. You do not need to use the balance until you need to pay the bills. You can repay your outstanding balance on the line when your business income catches up with the costs.

You can open a line of credit even before you need it while you should apply for a business loan if you have a specific and necessary capital expenditure. Lenders will require loan applications to specify a purpose. Lines of credit can be treated as reserve funds when your income is unstable. Determine what type of expense you need to fund so you can choose between a loan and a line of credit.