Business Loans vs Line of Credit: What’s the Difference?

You need to spend money to make money, and if your business needs to generate some capital, you will usually either take out a loan or a line of credit. It’s important to understand each of these options so that you can make the best decision for your business.

Let’s look at business loans vs lines of credit so you can choose the most suitable option.

What is a business loan?

A business loan functions similarly to a home loan – you borrow a lump sum that you will pay back in instalments (with interest). There are two main types of business loans.

1. Long-term business loans help you pay for big investments in your business, and you generally pay them back over a period of three or more years. This type of loan is usually taken out to make an investment that helps your business generate more revenue, eventually paying for itself. For example, a mechanic might invest in an expansion of their workshop space, allowing them to serve more customers at the same time.
   
2. As the name implies, short-term business loans are borrowed over a much shorter period (around six to twenty-four months). Also known as working capital loans, they give you a quick cash injection to help you cover shortfalls in your cash flow. For example, a café shop owner might use a short-term business loan to pay employee wages if they’ve had a slow period.

There are also more specific types of business loans, such as equipment financing loans and invoice financing loans. An equipment financing loan is used to buy new gear for your business, with said gear acting as collateral. An invoice financing loan gives you money to cover your outstanding invoices (with a fee).

Business loans give business owners a reliable way to access the capital they need to invest in their operation and stay afloat during challenging periods. Of course, the money borrowed needs to be invested wisely so that the debt can be paid off with future profits.

How to get a business loan

There are many places you can go to access a business loan, including banks and online finance lenders. Depending on where you choose to source a business loan, the approval requirements can be strict. Nobody wants to lend money to your business unless you can give them a reasonable expectation you will be able to pay back what you borrow. This means providing information such as bank statements and financial projections, as well as an outline of your business plan.

Essentially, you need to make a case for your business and convince the lender that you will spend the money wisely. You may also need to secure the loan by putting up some collateral, such as the equipment used in your business.

Your business credit score will also be evaluated by the lender. The better your credit score is, the more easily you will be able to access finance for your business.

What is a business line of credit?

A business line of credit functions like a business credit card, giving you the ability to borrow money against a specific credit limit each month.

Keep in mind:

• You can pay off the total amount you borrow each month or only make the minimum monthly payment. 
• If you only make the minimum payment, your remaining balance will grow and generate interest, making it more expensive to pay down later.
• You can use a line of credit to continually borrow new amounts as you pay them off, so you don’t have to reapply each time.

Like a short-term business loan, a line of credit is generally relied on to cover immediate expenses month-to-month. Some business owners will rarely access their line of credit but like to have it as a backup fund to cover any unexpected expenses that arise.

How are business loans and lines of credit different?

Let’s break down the differences between each type of business finance.

Business Loans:

• Based on instalments that you pay back every month. 
• You will receive a lump sum that you can use when you choose (you still need to make repayments even if you haven’t used the money yet). 
• Your business loan needs to be tied to a specific use, such as financing equipment or inventory.
• Business loans allow you to borrow and spend more than a line of credit but will have more eligibility requirements and may require that you put up collateral.

Lines of Credit:

• Based on a revolving line of credit – any outstanding balance will carry over month-to-month and generate interest.
• If you don’t access any funds, you won’t need to make any repayments.
• When you pay off a balance, you can access it again without needing to go through another approval process.
• Can be used to pay for any business need; it does not need to be tied to anything specific.

Which finance option is right for your business?

The choice to go with a business loan or a line of credit depends on your needs.

A business loan is appropriate if you are starting out or planning a major expansion of your business, giving you a large pool of money to make investments with. 

A line of credit is generally suited to cover short-term expenses that arise, allowing you to borrow only what you need each month. They are a great fall-back option to have when the unexpected happens.

OnDeck’s business loans can help support your business with an amount ranging from $10,000 to $250,000. Along with flexible 6 to 24-month payment terms, you can receive funds in as fast as one business day.

Frequently Asked Questions

Which is better, a small business loan or line of credit?

Whether a small business loan or a line of credit is better will depend on your business. Both types of finance are functionally different, making them appropriate in different circumstances.

Is a line of credit better than a loan?

A line of credit can be better than a loan if you need to cover smaller, short-term expenses in your business, such as paying staff wages or paying for a repair technician etc.

Is it better to get a business loan or a personal loan?

It’s better to get a business loan if you are trying to raise capital for business purposes. A personal loan is designed to help support your personal finances, which are not business-related.

Is a line of credit better than a credit card?

A business line of credit is superior to a credit card when you need short-term finance for your business.