When a business requires a cash infusion, they generally pick one of two options: a business loan or line of credit. However, these two forms of financing have different features, advantages and pitfalls. In order to implement a strategy that works best for your business, it is important to distinguish between the two and understand how they work. Read on to understand the difference between a business loan and a line of credit.
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Business Loans vs Lines of Credit
A business loan and a line of credit serve the same purpose: fulfilling the capital needs of a business. However, there are certain differences between the two:
- A line of credit is revolving credit and provides you with a balance that accrues interest. If the line of credit is not used, the borrower does not have to make payments. When the credit line is used, the balance can be paid in full or as much is affordable at the time; provided that the payment meets the monthly minimum amount. The unpaid balance accrues interest.
- A business loan, on the other hand, is a form of instalment credit. The borrower is given a lump sum and is expected to make monthly fixed payments. The repayments have to start right away, regardless of when the borrowed amount is used. You can use a business loan calculator to assess if the repayments are affordable and the schedule is manageable for you.
- Most business loans are reserved for a specific purpose or use; a line of credit can be used for any business purpose.
- Business loans allow you to borrow large sums as compared to lines of credit.
- Loans typically require you to assign collaterals and have stricter approval criteria as compared to lines of credit.
How to Determine the Right Type of Financing for Your Business?
Consider the following questions while trying to decide on the best type of financing for your business needs
- How much capital do you need?
- What purpose will you be using the capital for?
- What is more essential: predictability of a business loan or flexibility of a line of credit?
- Does your credit score meet the approval criteria set by lenders?
- Do you need to build your credit score? A line of credit for your business can help you build it and set up a good foundation for fulfilling financing needs further down the line.
In Conclusion
While a business loan or line of credit aren’t the only two financing options, they are certainly two of the most common and reliable ones. Before zeroing in on either option, assess your business’s performance, capital, financial needs, and goals for the future and account for all the relevant factors. This analysis will help you in determining the financing option that works best for your success as a business
FAQs
Q 1. Which type of financing is better for borrowing big sums?
A business loan allows you to borrow large sums.
Q 2. Which type of financing offers more flexibility of use?
A line of credit provides more flexibility of use.
Q 3. How does a line of credit work?
A line of credit is revolving credit and provides you with a balance that accrues interest. If the line of credit is not used, the borrower does not have to make payments.
Q 4. Why is a good credit score important?
A good credit score attests to your reliability as a borrower.
Q 5. Which type of credit is a business loan and a line of credit respectively?
A business loan is a form of instalment credit, and a line of credit is revolving credit.
