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(aka - No B.S. Talk About Small Business Loans )

Business Loans vs. Lines of Credit — Which is Better?

Considering a business loan? The options can seem overwhelming. Well, don’t be intimidated — we'll help you make sense of two very common options - small business loans and lines of credit. And take heart in knowing you are joining a long storied history of people walking in your shoes! Small business loans date back to Mesopotamia over 4,000 years ago, when farmers would borrow money to buy grain and livestock.

Today, the Chamber of Commerce estimates that 16% of small businesses start up with the help of loans, while the Small Business Credit Survey conducted by twelve Federal Reserve banks revealed that 70% of small businesses have outstanding debt.

When considering business loans, you will find many types with most falling into two primary categories — traditional loans and lines of credit. What’s the difference? And which one might be better for your business?

Table of Contents:

1) What is a business loan?

A business loan, as opposed to a business line of credit, is a lump-sum debt agreement whereby a lender hands you a lump-sum of cash. You must then repay the loan in installments, usually monthly.

The loan may be unsecured, or it may require you to put up collateral. You may be free to spend the lump sum as you see fit, or there could be stipulations placed by the lender on the use of the money. These loans may have fixed or adjustable interest rates, and interest rates are often (though not always) higher than with lines of credit. Rates for many loans and lines depend on credit scores, collateral and business performance.

If the loan is a fully amortizing loan, this means that by the last payment the loan will be paid off in full, including interest. If the loan isn’t fully amortized, a balloon payment may be due at the end, requiring you to either come up with a lump sum of money to repay or simply refinance the loan at that time.

2) What types of business loans are there?

Short-Term Business Loans

Short-term business loans have terms of 1 to 3 years, with loan balances typically up to about $500,000. Interest rates are usually favorable, though a line of credit may offer better rates. One of the biggest advantages of short-term business loans is the fast application process— some loans can fund as little as 24 hours after application.

Some short-term loans can take longer to fund, and this is particularly true of SBA loans. Even SBA Express loans - loans under $350,000 - can take as long as 30-60 days to fund. Interest rates are usually very good, but these aren't best for immediate cash needs.

To qualify, business owners usually need a good credit score, and the business must have been in operation for two or more years. However, some short-term business loan programs do exist for newer businesses and weaker credit profiles. In those cases, the lender may require the business owner to put up personal collateral.

Long-Term Business Loans

Long term loans range from $50,000 to $5,000,000 or more. Popular long-term business loans in the US are backed by the US Small Business Association (SBA) and range in terms from 7 to up to 25 years. Because the SBA guarantees a portion of the loan, a lender can assume more risk and can often accept less collateral than for a traditional bank loan.

Long-term small business loans can have favorable interest rates, but lines of credit may have better rates overall.The longer amortization schedule on long-term loans keeps the payments low even on higher loan balances. The downside is that they tend to have a more intensive and lengthy application process. SBA loans, in particular, can take some time – as much as 60+ days - to close.

Merchant cash advances usually range between $5,000 and $250,000, with very fast approval times - often within 24 hours. Merchant cash advances have the advantage of being flexible and not requiring collateral or carrying restrictions on the use of the money.

Merchant Cash Advances

Businesses that accept credit cards are often eligible for a merchant cash advance. These are sometimes called ACH loans due to the method of automatic repayment. This type of loan is basically a loan against the company’s projected future earnings, since repayment comes from future credit card receipts.

Merchant cash advances usually range between $5,000 and $250,000, with very fast approval times - often within 24 hours! Merchant cash advance loans have the advantage of being flexible and not requiring collateral or carrying restrictions on the use of the money.

Lenders usually need to see a few months’ worth of merchant account or bank statements. The downside to these loans tends to be the overall cost. Borrowing costs are often higher on merchant cash advances than many other loan types. However, many businesses find these loans incredibly helpful for short-term cash needs.

Invoice Financing or Factoring

Also known as “accounts receivable financing,” invoice financing is a type of business loan where the collateral is the company’s outstanding invoices, i.e. its accounts receivable. Loan balances average about 80% of the accounts receivable balance, with favorable terms and interest rates and fast funding, in as little as three days.

In some cases, depending on the age of the receivables and type of customers, lenders will finance up to 90% of receivables. These can be great sources of funding for a business with cash tied up in unpaid customer invoices.

Equipment Financing

Loans of up to $5,000,000 may be available for businesses in need of specific pieces of equipment. These equipment loans can be traditional bank loans, including SBA loans, or they can be loans by specialty lenders who focus on equipment financing.

For these loans, equipment can be very broadly defined and can include vehicles, software, machinery, appliances and specialized materials required for your business.

For equipment financing, use of funds will be limited to the equipment itself, and the equipment will act as collateral for the loan. Interest rates are usually favorable, and loans can be approved quickly, sometimes in as little as 24-48 hours.

Commercial Mortgages

If you own real estate used for your business, or you want to buy a building for your business, you would be a candidate for a commercial mortgage. Similar to a home mortgage, a commercial mortgage is a long-term loan secured by the property.

Commercial mortgage interest rates are very low, offering some of the lowest rates of any type of business financing.These loans are amortized over 20, 25 or even 30 years, so this translates into the lowest payment amounts.

Usually, commercial mortgage loan terms are shorter, however, meaning balloon payments will be due at the end of the term, requiring you to refinance. Most commercial mortgages carry terms of 5 to 10 years, though SBA loans used for commercial properties can have longer terms.

Buying a property for your business can be a fantastic way to increase the profitability of your business and increase its value long-term. Many owners find that the money they used to pay rent can be used to make a mortgage payment, plus by owning a building or property, they own an asset that will increase in value over time.

When you're ready to see what type of financing you qualify for, take just a few minutes and get started here.

3) What is a business line of credit?

A business loan is like a car loan, where a creditor loans a set sum of money and you repay the loan in installments.

By contrast, a business line of credit is more like a credit card. As with a credit card, the lender extends you a “credit limit”, rather than just handing over a lump sum of money. You are then free to draw cash against that line of credit limit at will.

At any given time, you can borrow no money against that limit, or you can borrow up to the maximum of that limit, just like maxing out a credit card. If you pay down that balance, the difference between the balance and the credit limit is freed up for you to borrow it again in the future.

Of course, you must repay the loan. The terms of the loan often include a minimum payment, though usually that payment doesn’t fully amortize the loan. In other words, you would have to pay more than the minimum payment in order to pay the balance in full in a reasonable period of time.

If you choose not to use any of the line, so it has a zero balance at any time, you do not pay any interest. When you do carry a balance, so some of the line is used, then interest charges apply. Interest rates on business lines of credit are often more favorable than the interest rates of business loans, depending on the credit score and collateral.

If you pay the balance in full, no interest charges will apply because there is no balance to assess them against. You are then free to borrow again up to your limit. This flexibility to borrow when you need money and pay back on your own schedule make business lines of credit very attractive to businesses with fluctuating needs. This can include seasonal businesses, or businesses that have spikes in receivables and collections, or businesses that are growing and need to spend on sales, marketing or fulfillment before receiving revenue.

This flexibility to borrow when you need money and pay back on your own schedule makes business lines of credit very attractive to businesses with fluctuating needs.

4) What are the advantages of business lines of credit?

● Flexible repayment terms.

● May not require collateral.

● Not required to carry a balance and incur interest charges.

● Little or no restrictions on use of funds.

● Very competitive interest rates.

5) What are the disadvantages of business lines of credit?

● Interest rates are usually variable.

● Payments are not fully amortized.

● Loan size may be restricted.

6) What are the advantages of business loans?

● Competitive interest rates.

● May fund quickly.

● Flexible — many types to choose from.

● Large range of loan amounts.

● Often have fixed interest rates.

7) What are the disadvantages of business loans?

● May require collateral.

● May be restrictive on the use of funds.

● May take time to process.

● May have higher rates than lines of credit.

8) How do you decide between a business loan and a business line of credit?

Deciding between a business loan and a business line of credit depends on the your type of business, your or your business credit quality and the reason you are seeking financing. There are no hard-and-fast rules, but here are some general things to keep in mind:

● If you want access to funds at various times, or for various purposes, consider a line of credit. It comes with the most flexibility.

● If you accept credit cards in your business – examples: restaurants, stores, contractors – and you do not need a long-term loan, you are a good candidate for a merchant cash advance. These can offer quick cash and ease of repayments.

● If you have good credit and no immediate need for the cash but an expectation of needing cash in the near future, consider a business line of credit. Sometimes it is best to apply for these and have them ready for when you will need to draw on them.

● If you need cash quickly and have uncollected invoices, consider invoice financing, or accounts receivable financing. These can offer quick cash while removing some of the pressure of collections.

● If you have specific equipment in mind to buy, whether vehicles, specialty equipment, or any other fixtures, furniture or materials to run your business, consider equipment financing. Usually, no additional collateral is needed.

● If you own commercial real estate or want to buy commercial real estate you can use to run your business, definitely consider a commercial mortgage loan. Owning a property for your business can be a very smart decision for the long-term value of your business.

● If you have been in business for a few years, need a higher balance loan, want very favorable terms, and have time for a longer application process, consider a bank term loan or SBA term loan.

When you're not sure what type of financing will be best, apply through a lending platform that offers lots of options from many lenders. This can give you fast information about what you qualify for, what type of loans are really options and how much you can borrow.


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