Term Loans vs. Revolving Credit: Making the Right Choice

When your business needs funding, it’s essential to choose the right financing structure. Two of the most common options—term loans and revolving credit—serve different purposes and come with distinct advantages and limitations.

In this comprehensive guide, we’ll break down how each option works, when to use them, and how to decide which is best for your business needs.

What Is a Term Loan?

A term loan is a traditional form of financing where a business borrows a lump sum upfront and repays it over a fixed period, usually with interest. These loans can be short-term (under a year), medium-term (1–5 years), or long-term (over 5 years).

Key Features of Term Loans:

• Fixed or variable interest rates

• Monthly or quarterly repayment schedules

• Often requires collateral or a strong credit profile

• Suitable for large, one-time expenses

Common Uses for Term Loans:

• Purchasing equipment or real estate

• Funding a business expansion

• Consolidating existing debt

Pros of Term Loans:

• Predictable payments help with budgeting

• Lower interest rates (especially for secured loans)

• Larger loan amounts available

Cons of Term Loans:

• Less flexibility than credit lines

• Harder to qualify for with bad credit

• Prepayment penalties may apply

What Is Revolving Credit?

Revolving credit allows a business to borrow up to a pre-approved credit limit, repay, and borrow again. The most common example is a business line of credit.

Unlike term loans, revolving credit gives you flexible access to capital when needed—perfect for managing fluctuating expenses.

Key Features of Revolving Credit:

• Reusable credit line with no fixed term

• Interest accrues only on the amount used

• Variable interest rates

• Often unsecured but can be secured for larger limits

Common Uses for Revolving Credit:

• Managing cash flow

• Covering short-term expenses

• Handling seasonal revenue fluctuations

Pros of Revolving Credit:

• Flexibility to use funds as needed

• No interest on unused funds

• Reusable without reapplying

Cons of Revolving Credit:

• Higher interest rates

• Lower credit limits

• Risk of overspending if not managed carefully

Term Loans vs. Revolving Credit: Side-by-Side Comparison

When to Choose a Term Loan

A term loan is ideal if your business:

• Is making a large investment like buying property or equipment

• Has predictable revenue to support regular repayments

• Needs to consolidate existing debt

• Can qualify for favorable terms based on strong credit

Example:
A manufacturing company takes out a $250,000 term loan to purchase a new piece of machinery, repaid over 7 years at a fixed rate.

When to Choose Revolving Credit

Choose revolving credit if your business:

• Needs ongoing access to capital

• Experiences seasonal cash flow fluctuations

• Wants flexibility for unexpected expenses

• Doesn’t want to pay interest on unused funds

Example:
A retail business opens a $50,000 line of credit to prepare for increased inventory needs during the holiday season and repays the balance in the following quarter.

Which Financing Option Is Right for You?

Ask yourself these questions:

1. Do you need a one-time lump sum or flexible access over time?

   • Lump sum = term loan

   • Ongoing access = revolving credit

2. Can your business handle fixed monthly payments?

   • Yes = term loan

   • Unpredictable revenue = revolving credit

3. Is this expense long-term or short-term?

   • Long-term investment = term loan

   • Operating expenses = revolving credit

4. Do you want to minimize interest costs?

   • Term loan may offer lower rates overall

   • Revolving credit only charges for what you use

Alternatives to Consider

If neither option feels right, you might explore:

• Business credit cards – great for small purchases

• Invoice financing – get advances on unpaid invoices

• Merchant cash advances – based on future revenue

• SBA 7(a) loans – offer term and revolving options

What is the difference between a term loan and revolving credit?
A term loan provides a lump sum repaid over time with interest, while revolving credit offers flexible, reusable funds up to a set limit and charges interest only on the amount used.

Conclusion

Term loans provide stable, structured financing for large projects, while revolving credit offers flexibility for fluctuating or short-term needs. Choosing the right one depends on your business goals, cash flow, and risk tolerance.