If you’re looking to grow your small business, you have two main financing options to choose from: installment loans and revolving credit. Installment loans give you a lump sum of cash up front that you pay back (with interest) in monthly payments. Revolving credit, on the other hand, provides a source of funds you can draw on and repay (with interest) as needed. Each has its own features, pros, and cons to consider as you research your business financing options.
Below, you’ll find the basics about installment loans, revolving credit, and the differences between the two so you can make an informed choice about which financing makes sense for your business.
What Is an Installment Loan?
A business installment loan is a type of small business financing that provides a fixed amount of capital you can use to cover business expenses. You then pay back the loan in fixed monthly installments that include both principal and interest for the duration of the loan term. For example, if your company takes out a $20,000 loan with a 7.5% annual percentage rate (APR) and a five-year term, your monthly payment will be $400.76.
Within the category of business installment loans, there are both long-term business loans and short-term business loans. Both are offered by banks, credit unions, and online lenders.
Qualification requirements for installment loans will vary depending on the lender. Bank and Small Business Administration (SBA) loans tend to have higher requirements in terms of time in business and credit scores, while online lenders may rely more on your sales and revenues to determine your eligibility. If you own a startup but have bad credit, there may be loan options for your business as well.
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Features of Installment Loans
Also known as installment debt, installment loans give you access to the working capital you need, whether it’s to expand your business or to get through a slow period. The downside to these loans is that they involve an ongoing commitment to regular payments that you’ll have to make for the duration of your loan term. Here are some features of installment loans to consider.
You’ll Make Monthly Payments
When you sign your loan agreement, you’re agreeing to make a payment (which includes both principal and interest) each month. If you choose a fixed interest rate, the amount you pay will be the same each month. This can make it easier for you to budget that loan payment among your other monthly business costs. Most installment loans come with fixed rates.
If you opt for a variable interest rate, your interest rate can change depending on market conditions. The small business loan interest rates for variable loans typically start lower than the interest rate on a fixed business loan, but they can go up or down over time. This may make it a little more difficult to budget. However, the loan terms typically limit how much it can fluctuate from one period to the next.
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You’ll Get a Lump Sum
Many times, you know you need a certain amount of money to cover a business expense, such as renovating a building or purchasing costly equipment. An installment loan, unlike revolving credit, gives you access to the amount you are eligible to borrow in one lump sum. Having that working capital may allow you to take advantage of business opportunities you wouldn’t otherwise have been able to afford.
You May Get a Tax Deduction
If you’re concerned that taking out a loan would mean you have to pay more in taxes, don’t be. The money you receive as a loan doesn’t count as part of your revenue. And a potential plus is that the interest you pay on the loan may be tax deductible.
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What Is Revolving Credit?
Revolving credit provides working capital or credit to cover small business expenses. It can include lines of credit, tradelines from vendors, and/or business credit cards. With each one, you’re approved to use up to a set amount of credit, but you aren’t required to take it all out at once. You only pay interest on the amount you actually borrow. Once you repay the funds, they are available to borrow again.
For example, let’s say you get a line of credit of $20,000 for your small business. In the first month, you take out $10,000 but pay back $5,000 that same month. That means that you’ll make payments (including interest) on the $5,000 you still owe, and you’ll still be able to draw on the remaining $15,000.
Features of Revolving Credit
Like installment loans, revolving credit has both advantages and disadvantages. It’s important to be aware of both when you’re choosing a way to purchase what you need for your business.
You Can Access Funds When and If You Need Them
Sometimes you can’t anticipate how much cash you’ll need to cover business expenses down the road. If that’s the case for your business, it can be helpful to have access to a line of credit instead of receiving a lump sum that you immediately have to start paying back.
Funds Are Always Available (Up to Your Maximum)
With an installment loan, the account is closed once you’ve paid off your balance in full. But with revolving credit, you can take out additional funds once you’ve paid down your balance. There’s no need to reapply for more funds after you’re initially approved.
You May Have an Option to Earn Rewards
Credit cards, which are one type of revolving credit, often offer rewards and perks that may help offset what you pay in interest. If you earn points for your transactions, you may be able to redeem those points for cash back or travel rewards. And while high interest rates are a potential negative for credit cards, if you pay your balance in full each month, you won’t be hit by high interest charges.
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Revolving Credit vs Installment Loans
While both types of business loans offer companies access to the funds they need, there are a few key differences to be aware of.
| Features | Installment Loan | Revolving Credit |
|---|---|---|
| How You Get Your Money | You receive a fixed lump sum when the loan is approved. | You take out what you need up to a fixed maximum. |
| When Payments Start | Payments (often fixed) include principal and interest and generally begin shortly after you receive the funds. | Payments are charged after you draw money and depend upon how much you’ve withdrawn. You may be able to pay a monthly minimum. |
| APR | 6.13% to 99$; often fixed. | 10% to 99%; often variable. |
| Possible Fees | Origination fee, application fee, administrative fee, prepayment fee, late fee. | Application fee, monthly and/or annual account fee, prepayment fee, late fee, origination fee with draw. |
Installment Loan vs. Revolving Credit: Which is Right For You?
There are key points to consider as you determine which small business loan is best for your small business.
A good first step is to figure out how much money you need for the specific purpose you’re borrowing for. You may be able to get more with an installment loan than you can from revolving credit. Consider, too, whether you need all the money at once or if your expenses will be spread out over time.
Next, you’ll want to determine how long a loan term you want. Short-term business loans will likely require higher monthly payments, which can eat into your budget. Long-term loans give you more time to pay the funds back, which can free up your cash flow for other expenses.
However, with long-term loans, you generally pay more in interest over the life of the loan.
Also consider whether you need cash or credit. If you’re purchasing a fleet of vehicles for your business, you may want a loan or line of credit, but if you’re just looking for a resource to help you purchase supplies from a vendor, you might just need a tradeline or business credit card.
An installment loan might be good for your business if:
• You need a lump sum up front.
• Your small business has a relatively steady income so you can budget for regular payments.
• Your small business is well-established and/or you have good credit, meaning you may be more likely to get good loan terms.
Revolving credit might be good for your business if:
• You want to be prepared for future financial needs but don’t require a lump sum right away.
• You may need access to relatively small amounts quickly to take advantage of business opportunities or pay for shortfalls.
• Your business has a need for perks offered by business credit cards. If you have to travel frequently for your company, for instance, a card that offers miles could help defray those costs.
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Installment Loan and Revolving Credit Options
Once you’ve researched the numbers and determined how much money you want to borrow, either through an installment loan or a revolving credit line, it’s time to start shopping solutions. Here are a few options you may want to consider.
• Traditional bank loan: This is a small business loan given by a bank or credit union. Qualification requirements are often stricter than with online business loans.
• SBA loan: Backed by the Small Business Administration, SBA loans typically come with better rates and higher loan amounts than traditional and online business loans.
• Business line of credit: Similar to a credit card, a business line of credit gives you a maximum amount to draw on. Once you pay it back, you can continue to use the funds up to the maximum credit limit.
• Equipment loan: An equipment loan is a small business loan used to purchase equipment. The equipment acts as collateral, which can sometimes land you a better interest rate.
• Merchant cash advance: A merchant cash advance allows you to receive funding in exchange for future credit and debit card sales. Merchant cash advances technically are not loans, and can be one of the most expensive forms of borrowing.
• Business credit card: Business credit cards may be ideal for those that want to take advantage of credit card perks and rewards. Interest rates are often higher than loans, so if you go this route, you’ll want to make sure you can afford to pay your credit card in full each month.
• Invoice factoring: Invoice factoring allows you to sell unpaid invoices to a factoring company. You get a percentage upfront, and then once the factoring company collects the payment, you get the remainder minus any fees. With invoice factoring, funding is typically fast but can be expensive.
Each option and lender will have different criteria, so do your due diligence when researching which options you will qualify for at the best rate.
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The Takeaway
Installment loans give a lump sum of cash up front that must be paid back (with interest) in monthly payments. Revolving credit, on the other hand, provides a source of funds a business owner can draw on and repay (with interest) as needed. Each has its own pros and cons.
If you’re seeking financing for your business, SoFi can help. On SoFi’s marketplace, you can shop top providers today to access the capital you need. Find a personalized business financing option today in minutes.
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