Small Business Loans: Installments vs. Line of Credit
As an entrepreneur, there will likely come a time when you need additional financing for your business.
When you need a cash infusion, you typically have two options: a business installment loan or a business line of credit. To help determine which solution is a better fit for your business, you first need to understand the differences between the two. In this article, we’ll take a closer look at installment loans (also called term loans) and lines of credit along with the benefits and disadvantages of each.
What is a business installment loan?
An installment loan provides the borrower a lump sum of money they must pay back in installments, or set amounts, over a pre-determined period of time, with interest. Installment loans typically have set repayment schedules with fixed interest rates. After you pay the entirety of the loan off, the account will close. Depending on how you plan to use the money, there are different types of business loans.
Business owners may seek out short-term financing to purchase inventory or bridge cash flow gaps. Repayment terms for these loans might be relatively short, between 6 and 24 months.
If you’re looking to make a large investment such as remodeling a building or purchase property, these loans generally have longer repayment terms of three years or more.
Equipment loans are a great option for business owners needing to purchase equipment or machinery. Typically, lenders or financing companies will lend you the money and secure the loan with the machinery you’re purchasing as collateral. The repayment term on these loans is generally up to ten years.
The Small Business Association (SBA) partners with banks and other lending institutions to offer loans to small business owners. There are different loan programs depending on your needs. These loans offer flexibility and benefits you won’t find with traditional loans, like longer repayment terms and lower payments. As a result of their advantages, this type of financing is highly competitive.
What is a business line of credit?
A business line of credit is a revolving type of credit, like a credit card. You are approved for a set amount, or credit limit, and you only owe interest on the funds you use. As you pay back your balance, those funds will become available to borrow again. With a line of credit, you don’t have to reapply for a loan every time you need extra cash. Many small business owners use a line of credit to cover ongoing expenses like payroll, bridge seasonal cash flow gaps, or cover unanticipated costs. A line of credit can also act as a safety net for when emergency situations arise, and you need access to funds quickly. If you never need to use the money, you won’t have any interest charges. However, the money is available if a problem were to arise.
What is the difference between a line of credit and a loan?
Both an installment loan and a business line of credit can help you take your business to the next level or provide you with an influx of working capital. While both of these lending options allow you to borrow money and pay it back within a set time frame, there are more differences than similarities between the two.
Revolving vs. Installment Credit
A line of credit is revolving, meaning you can consistently borrow up to your credit limit and as you pay back, your available credit is replenished. Revolving credit grants you the ability to borrow again and again without ever having to reapply. On the other hand, a loan is installment credit. This means the borrower gives you a lump sum of cash up-front, and you pay back the funds over a set period of time, with interest. You can’t borrow the money again unless you were to reapply and go through the approval process.
Perhaps the biggest consideration when choosing between a loan and a line of credit is deciding how you will use the funds. A business line of credit is a flexible financing solution that is readily available when you need it. Generally, business owners use lines of credit for short-term use cases like launching marketing campaigns, bridging off-season cash flow gaps, or covering emergencies. If a small business owner is seeking out a loan, they usually have a clearly defined purpose for the money. Loans are larger in size and are typically used to expand businesses or make large purchases, such as property or equipment.
Due to the size differences, small business lines of credit tend to have more lenient requirements than small business loans. Though, this can vary between lenders. Small business loans are generally available in larger amounts than lines of credit.
A small business loan locks you in to a fixed, predictable payment schedule for a set period of time. After receiving the funds, you will begin making payments immediately. With a business line of credit, you only need to make payments after drawing on the funds, and you only pay owe interest on the funds you carry over month-to-month.
After you pay off your small business loan, the loan account closes. If you find you need additional capital, you’ll have to reapply and go through the application process again. A business line of credit gives the borrower the flexibility to borrow up to their set limit and repay the debt repeatedly, without the need to reapply.
Which type of financing is better for my business?
The optimal solution for your business will depend on a few factors: how you plan to use the money, how much money you need to accomplish your goal(s), and how important financial flexibility is to you. If you have a specific idea in mind, such as expanding your business or purchasing equipment, then a business loan might be a better option for you. Business loans have fixed monthly payments, making them easier to account for in your monthly budget. On the flipside, if you’re looking for access to extra working capital with no restrictions, a line of credit might be your best bet. You only have to make payments when you borrow money, so if you never use it or you pay it off in full each month, you won’t accrue any interest. However, it’s important to note that some lending institutions might charge non-usage fees if enough of the line of credit isn’t used.
How do I apply for business financing?
At SouthState, we can help with the loan you need to set your business up for success. Whether that means adding a new storefront location, investing in top-of-the-line equipment, or just keeping your business running smoothly. With our bankers’ expertise and dedication to your business, we will work to secure the credit you need. Contact us today.