Traditional Bank Loans Vs. Lines of Credit
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When running a business, it’s likely that you’ll borrow money at some point in some form or other. There are various options when it comes to borrowing money. If you have to decide between bank loans vs. credit, then it’s useful to first understand how they are similar and different from one another.
Let’s take a look at everything you need to know so you’ll be prepared to make the right decision.
What is a Loan?
A loan is a lump sum of money that gets repaid with interest. Interest is the cost of borrowing money and is often set at a fixed percentage of the lump sum. Repayment typically happens over time in regular payments until the full amount borrowed is paid back. The majority of loans are amortized, meaning that each payment is the same amount.
There are a myriad of kinds of loans. Throughout life, people tend to take out loans for personal reasons, like a mortgage when buying a home or a student loan for education. Businesses take out small business loans to help cover their expenses.
What is a Business Loan?
A business loan is also known as a commercial loan. Loans are provided to help businesses with operational costs, hiring staff, buying inventory or for any other capital need. Business loans come in different forms, some of which include: a bank loan, invoice financing, microloans, business cash advances, cash flow loans, asset-backed financing, and mezzanine financing. Depending on your need and business structure, it’s best to research the types of loans you can receive to find out what works best.
What is a Line of Credit?
A line of credit allows borrowers to draw money and spend it up to their limit. Once the money is repaid, often with interest, then the credit can be spent again. It serves as a revolving account.
For example, if you have a business credit card, then you are given a business line of credit, or an amount you can borrow for the month. Let’s look at what this may look like with numbers. Say you have a business line of credit for $10,000 and you spend $3,000. Then, you have $7,000 in credit to still use before you hit your credit limit. Once you repay the $3,000, then your line of credit is back to $10,000.
Bank Loans Vs. Lines of Credit
There’s no right or wrong answer in terms of choosing between a bank loan and a line of credit. However, depending on your needs and timeline, one could be more beneficial than the other.
A business line of credit provides you with advantages like:
- Payment flexibility – you can choose how much to pay back each month, from the minimum payment to the total balance (or any number in between). Just be aware that you will pay interest on the balance.
- Readily available – a line of credit is readily available as part of your credit card offering every month.
On the other hand, a bank loan can be more useful in specific instances, including:
- Specificity – if you know exactly how much money you’ll need for a project or expense, then a loan could prove to be more cost effective as you’ll know the amount and repayment structure upfront.
- Budgeting – you can budget your business goal by allocating funds for the loan repayment, as well as the cost of the project or need.
An easy way to decide between a bank loan and a line of credit is to think of it this way:
- Choose a loan when you have a specific purchase or one-time investment (cost). Loan amounts are up to $5 million for a small business loan.
- Choose a line of credit for ongoing expense or a small need for cash. Loan amounts are up to $1 million.
Another big difference between the two is the interest rate and terms.
- Lines of credit tend to have variable interest rates, although fixed may still be an option. You can pay back minimums, or fixed weekly or monthly payments.
- A small business loan has a fixed interest rate, with loan terms from 1 to 20 years. You can pay it back in fixed weekly or monthly payments.
A Look at Your Options
Lines of credit and loans are offered based on assessments of your business. It’s possible that you will apply for a small business loan and be denied by a lender. When this happens, there’s no need to panic. There are alternative funding methods to consider like a merchant cash advance. At Uplyft Capital, you can simply apply for a merchant cash advance and receive capital almost immediately. Take a look at our programs to see what may be fit for your needs!
Picking Between a Loan Vs. Line of Credit
Both small business loans from traditional banks and business lines of credit have helped businesses stay afloat and prosper. To determine what is the right funding method for your business, start by determining the amount of capital you need. Then, take a look at your inflow of money and ability to pay back the borrowed amount. After you calculate interest rates and weigh your costs and benefits, you will be able to find the funding option to support your business goals.