Every business needs capital and when there is not enough it can harm your company or even run out of business. There are two main ways businesses can borrow the needed cash which is a business loan or a line of credit. A business loan and line of credit offer businesses the opportunity to leverage assets in exchange for capital and that capital can be spent on the operational needs of the business. There are some differences between business loans and lines of credit as well and it is important to understand them, so you know which decision is right for your business.
What Is a Business Loan?
A business loan, also called a term loan, provides funds to start, support or expand a business. It is made for a specific amount of money and is repayable over a certain period of time. The term is typically from one to 20 years and the amount ranges from $25,000 to $500,000. This type of loan is similar to a mortgage where the borrower receives a lump sum and then pays back the principal and interest overtime. Business loans have a fixed interest rate so each payment you make will be the same for the same amount for the life of the loan. It is also important to note that business loans come with other fees besides interest which include packaging fees, origination fees, prepayment penalties and more. A business loan is a good option for businesses who have predictable long-term expenses.
When to Use a Business Loan
The funds from a business loan can be used to open a new location, buy inventory, refinance debt, or take advantage of new opportunities for the business. It is important to be prepared with a business plan to explain to the lender why you need to borrow money. Showing what your plan is for the funds and how it will help your business increase its revenue and sales will appeal to the lenders. You want to be able to make the lender feel confident that your business will be able to repay the loan.
Lenders will most likely ask you to provide collateral for your loan in case you default on the loan and are unable to make the payments.
How to Get a Business Loan
There are many sources you can look into for getting a business loan. You can get a business loan from banks, direct online lenders, and SBA loans. Bank loans and SBA loans have stricter requirements for approval.
Before you apply for a loan, it is important to know both your personal and business credit score and have both credit reports to show the lender. By knowing your personal and business credit scores, you will know which types of loans you qualify for. The better your scores are, the more likely you will get approved for a loan.
What Is a Line of Credit?
A line of credit is simple to acquire and is very similar to a credit card where you are approved for a specific credit limit, withdraw the money as you need and make payments on the amount you have withdrawn. If you never use your line of credit, you will not have to pay interest on it. Most credit lines do not have closing costs, or they charge little for them if they do. With a line of credit you can qualify up to $500,000 and the interest rates start at around 8% with repayment terms of 1-2 years. If you need cash fast, then a line of credit is a good option for you.
When to Use a Line of Credit?
A line of credit is best for short-term financing needs and for operating expenses such as payroll, unexpected expenses and payments, or temporary cash flow shortages. The best time to apply for a line of credit is before you need it as you can use it to keep as an emergency fund for your business.
How to Get a Line of Credit
Lines of credit have less requirements as compared to business loans. Some of the requirements needed are you need to be in business for at least one year, have a credit score of at least 630, and over $180,000 in revenue.
Business lines of credit can be either secured or unsecured. Secured means they are backed by some type of collateral like inventory and accounts receivable.
Which is Best for You?
Both loans and lines of credit have their own advantages and disadvantages.
Pros of Business Loans:
- Fixed interest rates
- Predictable payments
- Able to finance large expenditures for a long term
Cons of Business Loans:
- No flexibility on what you have borrowed
- Often has additional fees
- Payments start right away
Pros of Lines of Credit:
- Borrow only what you need
- The amount borrowed is reusable
- Low interest rates
Cons of Lines of Credit:
- Short repayment terms
- Penalty for late payments
- Unpredictable payments make financial planning difficult
Whether you decide to get a business loan or line of credit, be sure to identify and review the options so you can make an educated decision.