For business owners, it’s important to know what is a line of credit and how it differs from a business loan. It goes a long way in helping you pick the right type of funding for your business.
Funding plays a very important role in the growth of any business. Access to funds ensures a smooth running of your operations. This then improves your performance and leads to better profits.
And for any business owner, there are two major ways to finance your business.
You could take out a loan or you could get funding through a line of credit.
Although they perform similar functions, both funding methods are not the same. They have different forms and structures. As a result, one type of financing will be more suitable for certain situations than the other.
Knowing this difference is key. It helps you decide which of the two to choose when you need an external source of cash.
That’s what this article will show you.
What is a Business Loan?
A business loan is a fixed amount of money that you borrow from a financial institution that you’ll pay back at a later date. To be precise, the money you borrowed plus interest is paid back in instalments within a specified time frame.
How much you can borrow depends on your credit rating and your relationship with the lender.
In some cases, you may need to tell the lender what you want to use the loan for. You could also be asked to provide collateral before the loan is approved. Everything depends on the initial agreement you made with the lender.
Business loans are best used to finance large, one-time projects. But you can also get a loan to purchase new equipment or to open up new office locations.
Simply put, a business loan may be more suitable if you’ll use it to expand your operations and increase growth.
What is a Line of Credit?
If we were to compare a line of credit vs business loan, know that the former is more flexible.
With a line of credit, the lender grants you access to a certain amount of money based on your credit limit. You withdraw what you need from this sum and pay it back however you want to. That means you can choose to pay off the full amount you borrow at the end of the month or only the bare minimum required.
Also, you only need to pay interest on the money you withdraw.
Now, as you repay the money you withdraw, your limit gets replenished. This makes it possible to draw again from it without seeking approval from the lender.
Lines of credit are ideal for little, short-termed business expenses. They come in handy when you need to buy extra inventory or to pay salary during seasonal lulls. They are also useful in case of an emergency.
6 Key Differences Between Lines of Credit and Business Loans
If you are wondering whether you should get a small business loan vs a line of credit, you must understand the six key differences between them.
Interest rate and fees
Business loans typically have a higher interest rate than lines of credit. But this depends largely on the lending institution and your credit score.
In addition, lines of credit have a monthly fee whether you draw from the account or not.
The amount of money you can borrow depends on your credit rating and the lender. However, business loans are often bigger than credit lines. This is often true regardless of credit rating.
A business loan’s repayment schedule is more strict and rigid. You have to pay back the money you borrow in fixed sums over a specified period of time. You also have to start making payments as soon as you get the loan.
Meanwhile, lines of credit have a more flexible repayment schedule. You only need to pay back after drawing funds. And you can pay the bare minimum at different times or the lump sum you borrowed at once.
The requirements for lines of credit are more relaxed than those for business loans.
In order to get a business loan approved, you will need to provide information on what you want to do with the money. You will also tell the lender how you plan to finance the loan. But you don’t need to provide such details to get a line of credit.
Keep in mind that the requirements for both funding types depend on the lender.
Business loans are taken for specific, one-time finances. They are ideal if you want to carry out a major project and need a sizable amount of money.
A business line of credit, on the other hand, is often used for smaller business expenses. It allows you to get funding without committing to a lump sum.
If it turns out that your current business loan isn’t enough for what you need it for, you’ll need to make another application to get additional funds.
But with a line of credit, you only draw money based on how much is made available by the lender. You free up more money to borrow when you pay back what you owe. And you don’t need to reapply to withdraw the money.
Get the Right Funding For Your Business
When choosing to fund your business with either a loan or a line of credit, you need to ask yourself three questions:
- How much do you need?
- What do you need it for?
- How do you want to repay the money?
Generally, a business loan is suitable when you need larger sums for specific purposes. Meanwhile, a line of credit is ideal when you need smaller sums with flexible repayment plans.
If you need further assistance, Unsecured Finance Australia is here to help. Apply online and you can receive your approval within 24 hours.
Find out more by taking a look at our unsecured business loans.