Which is a better choice for you?
Financing a business is complicated. Even the healthiest companies often find themselves in need of liquid cash that they do not have available. Whether a business owner plans to expand into a larger location, renovate a property, or simply needs money to purchase materials and supplies, a business loan or business line of credit might be the right answer. While both options are available to healthy businesses, it is essential to consider the pros and cons of each option, and how they will affect the company before making a decision and signing on the dotted line. Traditional term loans and lines of credit are incredibly different products and should be used for various needs, so knowing what the difference is will help you make a more informed decision.
Business Term Loans
Term loans are the type of loan that most people are familiar with. In this scenario, a business owner applies for a business loan for activities related to financing a business, and, if approved, receives one lump sum from the lender. The money can be used for a variety of business purposes, including expansions or renovations. The term loan must be paid off over time, based on agreed upon terms. This type of loan is closed, meaning the entire sum of the loan is given to the applicant upon approval. The applicant cannot request further funds or ask for it to be released in a series of payments. The payback terms are also set in stone, as is the annual percentage rate (APR). These loans are attached to a timeframe, like 60 months, and each payment is a predetermined amount that must be paid by a certain day each month.
Business term loans are best suited for individuals who have a project in mind. For a term loan to be approved, the lender will want to know what the money will be used for, and how it could potentially increase the profitability of the business. This information is used to access an applicant’s ability to pay off the loan and increase their profits. While the APR on term loans is typically higher than the APR on lines of credit, the ability to have set payments each month for a large project can be beneficial for future planning.
Business Lines of Credit
A line of credit works like a credit card but is related to financing a business. A business owner can open a line of credit with a local lender. They may use the line of credit for anything related to the business, including inventory, expansion, renovation or materials. With a business line of credit, an applicant, if approved, is given access to a specified amount of money; for example, $50,000. The revolving line is dependent on your limit and how much you spend each month. For example, if you use $25,000 one month, you will have access to $25,000 that is left on the revolving line. If you pay off the $25,000, your available credit will jump back up to $50,000 without the need to reapply.
To be eligible for a business line of credit, an applicant will need to show that their business is healthy and profitable. A line of credit should not be used for daily operations, but instead, used for emergencies or as a gap between needed supplies and payment from a client or vendor. The APRs are usually lower than that of a traditional loan and can serve as an emergency back up when necessary. Lines of credit will need to be carefully managed to ensure payments are made on-time, or the applicant risks a significant jump in the interest rate of the line.
Both business loans and business lines of credit are essential for financing a business, whether it's a family-owned outfit or a multinational company. In most cases, a business will need access to additional funding if it plans to expand or to build a stronger future. Much like in your personal life, managing a business line of credit or a business loan will need to be done with great care, and substantial consideration should be taken before opening either option. It is also a good idea to sit down with your accountant and a business advisor before making a final decision on a loan or line of credit to ensure your business is healthy enough to sustain additional debt.