What is the Difference Between a Small Business Loan and a Line of Credit?
Whether you’re just starting your small business, planning to expand your business, or making huge investments, you need enough financial capital.
There are various sources where you can access small business loans to finance your business. Here, the best capital for your business includes a small business loan and a line of credit.
In this guide, we’ll go through the two sources of small loans. We’ll also look at the significant differences between the two.
But, before we get to the differences, let’s find out the importance of small business loans for startup businesses.
Importance of Small Business Loans for Startup Businesses
Based on 2021 statistics, 56% of small businesses sought some financing. Indeed, small business loans can help you achieve the following:
- Enlarge your business
- Explore new business opportunities
- Attain other business assets
Accessing small business loans can refinance your current business loan. You can discuss your business needs with a bank or credit union financial officer. They will review your business proposal and decide on your loan application.
So, once you think financial, you’re not limited to options. Apart from the term loan, you can also benefit from loan refinancing.
If you want to grow your business, there are many sources to look for finances. The small business financing program makes it easy for small businesses to get loans. Different financial institutions offer this program. And they’re fully responsible for the loan approval.
Applying for a small business loan enables business owners to access reliable capital. You can borrow what you need. And you get to access the cash in your bank account within 24 hours.
Again, once you sign up for the small loans, you’ll be able to set your pre-approved limit. The limit is then updated monthly, depending on your business performance.
You can withdraw any amount you need within your limit. Most significantly, there are no hidden charges. The interest rate is also fixed. So, with such working capital, you can realize your ROI faster than you imagined.
Here, the application process features simple steps that take less than ten minutes. You should open a bank account online to secure a connection. Afterward, the lender will let you know how much you can get considering your credit score.
With short-term small loans, you get money for your ongoing operational costs. This can allow your business to stay afloat even if profits are low. Indeed, it is essential to keep money flowing through your business. That way, you can continue bringing in new clients to boost revenue. This helps make up for other possible losses.
To know how your business is fairing, you can use the ROI calculator. This is a form of investment calculator. It allows you to estimate the profits or losses on your business investment.
What Does a Small Business Loan and a Line of Credit Mean?
Small Business Loans – A given amount of working capital lent to a small business by lending entities.
The concept here is simple: you request a small business loan through an application. And once the lender approves your request, the money comes straight to your account. This is where the lender deposits the funds.
Line of Credit – This one operates similarly to a credit card. You’re allowed to borrow up to a given limit. In addition, you have different payment options, unlike a small business loan.
You can either pay the total amount monthly or opt for the minimum payment. Note that, you will only pay interest for the amount you draw.
Unlike small business loans, a line of credit doesn’t offer an end-date and a repayment plan. A line of credit depends on the amount you draw and is revolving.
Now that you understand the difference in definition between the two, let’s proceed to terms.
Differences Between a Small Business Loan and a Line of Credit
To show the differences between the two, we’ll explore five factors that cut across small business loans and a line of credit. These factors include:
- Interest Rates
Now, let’s dig deep into each factor above.
A small business loan has various terms that depend on the loan amount you apply for. In addition, the collateral you provide and your business needs influence small business loan terms. Business loans in most countries don’t exceed five years unless the loan belongs to the real estate category.
Contrary to small business loans, a line of credit has a term line of up to 10 years. During this period, the line of credit issuing bank has the power to call the line due annually.
As such, the bank can cancel your line of credit. At the same time, you’ll have to pay all outstanding balances if the bank goes by that option.
When you’re seeking a loan for your small business, the amount you indicate isn’t a determining factor for approval. What matters to the lenders is your organization’s skills, industry knowledge, and why you’re applying for the loan.
On the contrary, credit scores matter when applying for a line of credit. Also, duration in business is applicable when applying for a line of credit.
When banks approve financement capital for your small business loan, the bank holds them until the moment you need the funds. This is because small business loans are for a specific purpose.
That said, you use the money for business loans once. You can apply for this through online personal loans. This is a sure way to increase your chances of securing a new small business loan.
On the contrary, a line of credit is set up in advance. Besides, a line of credit has a limit that corresponds to your credit score. It’s common for digital businesses. Of course, you don’t use a line of credit once as it is revolving.
In most countries, a line of credit is more difficult to get than a small business loan.
Payments differ for both small business loans and a line of credit. First, you pay consistently month after month for a small business loan.
You have to pay monthly since you agreed with the lender on a fixed interest rate. Also, payments remain the same for the entire period you have to pay. As such, you can easily predict payment for your small business loan.
Contrary, a line of credit operates differently. You’re to pay for the amount you draw. That means the amount you pay changes from time to time. Therefore, it’s hard to predict the amount you’ll pay for a line of credit.
● Interest Rates
A small business loan from equity financing offers you higher interest rates. In addition, small business grants support small businesses with small loans. The interest rates of small business loans hardly change. However, if you default, a penalty might apply.
On the contrary, a line of credit does not have a fixed interest rate. In this case, what you pay as interest depends on the amount you draw. Generally, a line of credit has lower interest rates than a small business loan.
If you draw a small amount of money, the interest will be small. However, if you draw a huge amount of money, the interest will be as much. The interest rate for a line of credit changes from time to time.
In the world of business, the two, small business loans and a line of credit, play vital roles. They come to the aid of small business owners with a shortage of either term loans or small loans.
Therefore, understand the differences between the two types of loans above. The information you gain helps you make outstanding decisions for your business. Also, you become aware of the valuable resources at your disposal.
In the end, you have to consider the different financial needs of your business and determine its track record. You should also have long-term goals to determine the best financing to go for.