Let’s say you need some new financing for your small business. How do you choose between a business line of credit vs. a loan? This article explains the differences between the difference between two options and shows you how to figure out which one makes the most sense for your particular business needs.
Key Points
• A business loan provides a lump sum of money and can be useful for specific financial needs or debt consolidation.
• If you’re considering a business line of credit versus a loan, it’s important to know that the line of credit offers more flexible withdrawals and repayment, as well as potentially easier requirements for approval.
• Repayment of a business loan typically involves fixed monthly installments covering principal and interest paid over a predetermined period.
• Much like a credit card, a line of credit generally allows businesses to repay funds and borrow them again, up to a set limit.
• Lines of credit can be helpful for managing short-term cash flow fluctuations and covering unexpected operational costs.
What Is a Business Loan?
A small business loan is a common type of financing that gives your company a one-time injection of capital. In fact, in late 2024, 18% of nonemployer small businesses reported applying for a business loan within the past year to help finance their company.
Taking out a loan can be beneficial during any stage of business, whether you’re looking for a startup loan or implementing strategic growth plans for a mature company. After you receive the lump sum, you’ll repay principal and interest over a set term that usually lasts at least three years. Fixed interest rates are typical, meaning that the monthly payments will be consistent, making it easier to budget.
What Is a Business Line of Credit?
A business line of credit vs. a loan can provide funding as you need it, rather than as a one-time lump sum. During the initial draw period, this form of revolving credit lets you borrow up to your credit limit, while interest accrues only on your outstanding balance. Whenever you want to draw on your line of credit, you simply initiate a transfer from the financial institution that’s providing it, usually through online banking, a check from your business checking account, or a linked account.
You’ll typically have a minimum monthly payment based on your balance. As you repay that amount, your credit line is replenished so that you can borrow again in the future.
Eventually, your draw period will end and those minimum payments will convert to payments that cover principal and remaining interest over your repayment period. You may also be able to apply to renew your draw period.
Key Differences Between Business Loans and Lines of Credit
There are several major differences between a business line of credit vs. a business loan, including the following:
| Feature | Business Loan | Business Line of Credit |
|---|---|---|
| Funding Availability |
• One-time funding |
• Ongoing availability of funds up to a set credit limit |
| Repayment |
• Typically regular fixed payments |
• Minimum payments based on outstanding balance, followed by a period during which you repay principal and remaining interest |
| Interest |
• Usually fixed rate; charged on full amount |
• Usually variable rate; charged on outstanding balance |
| Financing Renewal |
• New application required |
• Continual withdrawals allowed during draw period; may be a renewal option when draw period ends |
| Potential Fees |
• Origination, application, and early repayments fees |
• Origination, annual maintenance, and draw fees |
Pros and Cons of Business Loans
For entrepreneurs, there are both benefits and drawbacks to a business loan vs. a line of credit.
Pros:
• Well-suited for large purchases
• Flexible fund uses
• Predictable repayment terms
Cons:
• Funding times vary depending on lender
• Must reapply for new financing
• Eligibility criteria and documentation may be onerous
Pros and Cons of Business Lines of Credit
If you’re considering a business line of credit, you’ll want to review these advantages and drawbacks.
Pros:
• Funds (up to the credit limit) are available when you need them
• Flexible fund uses
• Interest is due only on what you use
Cons:
• Repayment amount is less predictable
• Balance may need to be repaid more quickly than for a loan
• May come with multiple fees
When to Consider a Business Loan
A business loan can be a strategic way to help your company in any number of situations. When you need a large lump sum for a specific purpose, it may be worthwhile to consider a loan.
For instance, if an injection of working capital could help your company grow by expanding its operations or purchasing a competitor, you might want to look at a loan. Or if you’re undergoing a short-term financial challenge, business loan funds might help cover your cash flow — assuming you can afford the payments.
Another common use for a small business loan is to consolidate or refinance higher-interest debt. This can be a good strategy if you can qualify for better financing terms that either save you money on interest or make your payments more affordable.
When to Consider a Business Line of Credit
There are several reasons you might want to contemplate a business line of credit vs. a business loan. One is to help cover cash flow gaps, especially for seasonal businesses or those that need to pay for inventory upfront. A line of credit can also help with day-to-day operating expenses, such as payroll and rent, especially for companies with tight margins.
Alternatively, while you wouldn’t want to take out a business loan on spec, a business line of credit can serve as an emergency fund. You can use the funds to cover unexpected expenses and repairs — or to take advantage of time-sensitive growth opportunities.
How to Qualify for Each Type of Financing
Different lenders may each have their own eligibility requirements for different types of business loans. That’s one reason that it’s generally useful to shop around for funding to find the best option available to you.
But in general, both line of credit and business loan qualifications can include the following:
• Business and personal credit scores
• Revenue
• Time in business
• Debt-to-income ratio
• Business plan
• Collateral
• Industry
• Financial statements
• Loan amount and purpose
Alternatives to Loans and Lines of Credit
It may be worth considering all of your financing options before choosing between a line of credit vs. a business loan.
• Equipment financing: An equipment loan is a form of secured financing that lets you purchase hard assets for your company. The equipment serves as collateral, which could help keep your interest rates lower.
• Business credit cards: A small business credit card can help cover business expenses while also potentially earning rewards. It can also be an easy way to start building your business credit score.
• Small Business Administration (SBA) loans: SBA loans are backed by the federal government and provide diverse financing options, from microloans to multi-million-dollar loans.
• Crowdfunding: If you don’t qualify for traditional business financing, you could try crowdfunding to raise capital. You can offer either business-related rewards or equity to your backers, or you might simply accept donations.
• Invoice financing: With invoice financing, the lender pays a portion of your invoices before your clients have paid the bills. Then you pay a fee out of the balance once the invoices have been paid in full.
• Merchant cash advance: A merchant cash advance is another way to get paid ahead of time. You get money from the lender upfront, then repay the borrowed amount from a percentage of your future sales.
How to Choose the Right Option for Your Business
Lots of financing options are available to business owners today. How do you know which is best for your company? There are several factors to consider.
First, assess what your company needs. If you’re looking to make a major investment that requires a lump sum of cash upfront, a loan may work better. If you’re interested in being able to cover payroll during a slow season or having funds in reserve for emergencies, a line of credit may serve you better.
Next, look at the eligibility requirements for a business line of credit vs. a loan. You may need to meet certain revenue and time in business qualifications. Knowing what’s needed can help steer you toward the options you’re more likely to qualify for.
Finally, consider the costs of each financing structure, including the interest rate and any accompanying expenses, like origination or account maintenance fees. A business loan calculator can help you estimate the total cost of different loan terms.
The Takeaway
When you’re choosing between a business line of credit vs. a loan, your ultimate decision should depend on your company’s specific needs. Once you’ve determined what exactly you’re looking for, one of the best ways to figure out the option that will work for you is to compare multiple financing offers.
If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.
FAQ
What’s the main difference between a business loan and a business line of credit?
A main difference when you’re looking at a business loan vs. a line of credit is that a business loan provides you with a single lump sum, while a business line of credit gives you access to a credit line to draw from when you need it.
Is a business loan or a line of credit easier to qualify for?
It can be easier for a business to qualify for a line of credit versus a loan, especially when it comes to revenue and time in business requirements.
Can I have both a business loan and a business line of credit?
Yes, it’s possible to qualify for both a business loan and line of credit at the same time. Lenders will review your company’s debt-to-income ratio as part of the application process. As long as they believe you can afford repayments on both, you may qualify for both.
How does interest work on a business line of credit?
Typically, interest is charged on the outstanding balance, not on your available credit limit. Rates are usually variable, and you’ll likely have to make only minimum payments during the draw period. Once you enter the repayment period, you’ll have larger payments as you repay both interest and principal.
Are business loans or lines of credit better for startups?
It depends on the startup’s financial needs. A business loan is better suited for a one-time purchase, while a line of credit can help cover ongoing costs.
Photo credit: iStock/Drs Producoes
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