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Line of credit vs term loan: how to choose the right option for your business

Capitalise – Apr 08, 2024

Are you trying to decide whether a term loan or a line of credit is the best way for your business to access capital? Each comes with its own set of advantages and considerations, tailored to different business needs and circumstances.

Let’s delve into the specifics of each option to help you make an informed decision that aligns with your business goals and financial situation.

Line of credit

A line of credit provides your business with access to funds up to a predetermined limit. This flexibility allows you to borrow and repay funds as needed, similar to a credit card but typically with lower interest rates and larger limits. 

Advantages of a line of credit

  • Flexibility: one of the key advantages of a line of credit is its flexibility. You have the freedom to borrow only the amount you need, when you need it. 
  • Interest only on amount used: with a line of credit, you're only charged interest on the amount you've borrowed, not the entire credit limit. This can result in cost savings compared to term loans where interest accrues on the entire loan amount from the outset.
  • Fast approval: a line of credit is typically quick to secure, making it a great option if you need to access cash fast. 
  • Unsecured: a line of credit is usually unsecured, meaning you won’t need to provide any assets as collateral. 

Disadvantages of a line of credit

  • Variable interest rates: unlike term loans which often have fixed interest rates, a line of credit may have variable rates. While this can lead to lower rates initially, it also introduces the risk of interest rate fluctuations over time.
  • Unpredictable repayment: as the interest rates and the amount you draw down can vary, your monthly repayments will not be fixed. This means that you could have unpredictable repayments which can make it difficult to forecast your cash flow. 
  • Smaller loan amounts: a line of credit tends to provide access to a smaller amount of capital than you may be eligible for with other types of business loans. 

Term loans

A term loan involves borrowing a lump sum of money for a specific period, with fixed interest rates and a predetermined repayment schedule. Term loans can be short term (3 months up to 24 months), or long term (2 years+).

Advantages of a term loan

  • Predictable repayment structure: term loans offer clarity and predictability with fixed monthly repayments. This can allow you to budget and plan effectively. 
  • Longer terms available: term loans can be used for significant investments such as purchasing equipment, or an expansion project. 
  • Stable interest rates: depending on the loan terms, you may benefit from fixed interest rates. This means you’ll be shielding your business from market rate fluctuations and allowing for easier long term financial planning.

Disadvantages of a term loan 

  • Limited flexibility: unlike a line of credit, term loans provide a fixed amount of funds upfront, which may not be suitable if you need ongoing access to flexible finance.
  • Interest on entire loan amount: Interest accrues on the entire loan amount from the beginning of the term, regardless of whether you use all of the funds available. This can result in higher overall interest costs compared to a line of credit.

Which option should your business consider?

When deciding between a line of credit and a term loan, it’s essential to assess your business’ specific needs and financial situation 

 

Consider a line of credit if:

  • You require flexibility in managing cash flow fluctuations.
  • Your funding needs are variable or short term.
  • You want access to ongoing credit for unexpected expenses or opportunities.

 

Consider a term loan if:

  • You have a specific project or investment in mind with a defined funding requirement.
  • Predictable repayment schedules align with your budgeting preferences.
  • You’re looking for long term financing for growth. 

 

Plan your business finances smartly

Before making a decision, it’s helpful to understand the potential costs involved with each financing option. Use our business loan calculator to estimate monthly repayments and total interest costs for each type of loan. This tool can aid in making an informed decision that aligns with your financial planning and business strategy.

For those interested in a specific type of loan geared towards vehicle financing, consider exploring options for a business auto loan. These loans can provide the capital needed to acquire vehicles crucial for your business operations.

Ultimately, the choice between a line of credit and a term loan should be guided by a thorough evaluation of your business’ financial circumstances and strategic objectives. When you search for funding with Capitalise, our dedicated team of funding specialists will work with you to understand your specific needs. With their expertise, they can help you find a suitable option for your business. 

It’s also important to bear in mind that you’ll likely need a good business credit score to get a line of credit or a term loan. You can check your business credit score before applying for funding when you sign up to Capitalise.

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