Loan or Line of Credit
Running a business can rarely be achieved with your own financial capacity alone, and without any outside help. Due to the complexities of running a business, it is likely that you would need some outside help to sustain your business at one point in the life of your business. Traditional lenders have created a way to help out small business owners. They are in the form of business loans or lines of credit for small business financing.
Let us now explain each of these terms.
- Business loan: A business loan is essentially a fixed interest loan. In a business loan, you borrow a set amount and repay it in fixed monthly installments over a number of years which can range from 5 to 10 years or 30 years.
- Line of Credit: A line of credit on the other hand is a loan balance extended to a customer (usually by a bank). The borrower will be permitted to maintain a loan balance and not draw down more than the maximum loan balance. The borrower can draw down the line of credit at any time, and the beautiful thing about the line of credit is that interests are paid only on the used portion of the line of credit while no interest is paid on the unused portion.
When choosing between a business loan and a line of credit, you have to take into consideration the advantages and disadvantages of each when making your decision. Let us now try to compare and contrast between the business loan and a line of credit.
Differences between a business loan and line of credit
- Monthly payments: Monthly payments are fixed during the life of a business loan. You start paying back the loan immediately and payments are amortized for a number of years. The payment for a line of credit is based on the amount of money actually used up or borrowed; this means that if you do not use the line of credit, there would be no need for payments.
- Use and Timing: A business loan is gotten when a specific purpose for it arises. Because of how cumbersome the process is in getting a loan, businesses do not get one for trivial matters which does not create value for the company. Instead they get loans to finance activities that would make more money for the business. A line of credit on the other hand is set up before the need arises and it can serve multiple purposes as opposed the specific purpose of a business loan. Line of credit can help finance account receivables, payroll or any other need if there are unexpected cash shortages.
- Interest rates: Interest rates are fixed in a business loan, and they are often high and not encouraging. A line of credit on the other hand may have variable interest rates; these interest rates may increase when there is a default or when the borrower exceeds his maximum loan balance.
- Renewals: Business loans can not be renewed after paying it up unless you want to take up another loan. A line of credit is revolving and can be used multiple times.
- Flexibility: A business loan is rigid, once you take it, you take it; you then have to bear the cost by paying interests on the loan along with some part of the original principal monthly. A line of credit on the other hand is very flexible. Borrowers can borrow irregular amounts as the need arises.
I hope this post would help you in deciding what method of finance is best suitable for your business need.