What is the Difference Between a Business Line of Credit and Business Loan?
Understanding all your options for business financing is crucial. There are two primary types of funding businesses use to meet their goals: business loans and business lines of credit. While both offer financing, there are key differences, and they serve separate purposes. As a business owner it's important to understand what's right for your business. Read on so you can make an informed decision that's right for you.
What is a Business Loan?
A business loan pays out a lump sum of money, which is repaid monthly with fixed payments over a number of years. This is also known as the term, which is often between one and seven years. It's generally used for large, one-time purchases, often secured by equipment or real estate. Some key features:
- The full amount is deposited to your business account in one lump sum
- Generally does not require collateral up to a certain amount (different per lender; ask yours what the limit is)
- Apply with a specific plan for funds; most lenders will want to know what you will do with the funds
- Repaid over a set term, generally between one and seven years
- Fixed interest, compared to variable for a business line of credit; some business loans offer variable interest, ask your lender for details
- Ideal for large purchases like equipment or expansion costs
- Approval amounts are generally higher compared to a business line of credit
- Stricter qualification requirements often requiring collateral compared to a business line of credit; a few variables affecting qualification include annual revenue, and years in business, among others
What is a Business Line of Credit?
A business line of credit is similar to how a credit card works. You're approved for a maximum amount, which you can borrow from and repay as needed. You only pay interest on the amount you borrow. Some key features:
- Access to the full amount, borrow what you need up to your credit limit
- Make transfers from your business line of credit to your business checking account through business online banking or the bank's business mobile app
- Unsecured up to a certain amount which varies per lender; ask yours what the limit is
- Can be used for any business expense such as supplies, equipment, furniture, or working capital
- As you repay, you can borrow again and again
- Variable interest, charged only on the amount borrowed
- Great to help manage cash flow, for unexpected expenses, or for short-term needs such as seasonal inventory
- May come with additional fees such as annual, draw, or inactivity fees; be sure to ask your lender specifically about fees related to business lines of credit
Differences and Similarities of a Business Loan and Business Line of Credit
While both provide the funding you need for your business, sometimes one option is better than the other.
| What You're Looking For | Solution | |
|---|---|---|
| Disbursement | Paid to your business account in one lump sum | Transfer funds into your business account to use as needed, similar to a credit card , or use it for overdraft protection (ask your lender for details) |
| Repayment | Fixed monthly payments over a set term | Monthly payments vary and can be interest only or a set minimum payment, depending on the amount owed |
| Interest rate | Generally higher than a line of credit | Generally lower than a loan |
| Interest charge | Charged on the full amount | Charged only on the amount you borrow |
| Best for | Large, one-time purchases | Seasonal cash flow needs |
| How to get new funding | Reapply for a new loan | Request a credit limit increase |
| Collateral required | No, up to a certain amount, usually a higher non-collateralized limit than a business line of credit depending on a number of factors, collateral may be required in some situations no matter the amount | No, up to a certain amount; generally lower non-collateralized limit compared to a business loan depending on a number of factors, collateral may be required in some situations no matter the amount |
| Risks | No access to more funds when needed; you must reapply and go through the approval process instead Must pay interest on the full amount, even if you don't use it right away | May overspend as there are no restrictions up to the credit limit Increased payments as you borrow higher amounts over time |
| Best for | Large, one-time purchases | Seasonal needs or cash flow management |
| Other uses |
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When is a Business Loan a Better Option?
It's a good choice when you need a large amount of funding for a specific need. They are also great if you want to have set repayment terms with a defined end date and will not need funds for future purchases. If this is the direction you want to go, ask yourself a few questions to help you get started before applying:
- How large of a loan will you need?
- Will you need access to funds later?
- How long will you need to repay? One year or more?
- What will you use the funding for?
When is a Business Line of Credit a Better Option?
A business line of credit is the better choice if you want flexibility. If you want access to funds as needed, to manage seasonal cash flow, or to have it available for emergencies, it's an ideal option. Before applying, ask yourself a few questions to request a good credit limit for your business needs:
- What business needs will you use the line of credit for?
- How much do you usually spend to get ready for the busy season?
- Are there other needs that might come up before you can repay to pay down the line of credit?
- Will the amount you choose meet your short-term and long-term needs?
WaFd Bank is Here to Help
Our knowledgeable business bankers are available to help you manage success and have the expertise to become a trusted advisor to you and your team. With products that grow with your business and comprehensive tools to seamlessly manage it all, WaFd Bank is built for business. After over 100 years, we know what it takes to help you succeed, from start to legacy. Visit your local branch or give us a call at 800-324-9375 to experience the difference WaFd Bank can make for you.
Loans subject to credit approval, terms and conditions may apply.
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