Business loan vs. line of credit

A business loan offers funding that small businesses need to make strategic purchases to boost growth. Small businesses can choose from many types of business loans, including term loans and lines of credit.

According to the Federal Reserve’s 2023 Report on Employer Firms, business lines of credit and business loans are the top financing sources that employer-based businesses apply for. Forty-three percent applied for business lines of credit, while another 34 percent went with a business loan.

Of those applications, 76 percent were approved for a line of credit, while 66 percent were approved for a business loan.

There may be overlap in how you can use the funds from either loan. The loan amount you need, interest rate and ability to reuse credit can help you choose the best option for you. Let’s dive into the features of business loans versus lines of credit.

What is a business loan?

A business loan is a contract between a business and a lender offering funds to the business that it will have to repay. The business can use the borrowed money to grow its operations, buy property or expand into new products and services. The purpose of the loan is to boost the business’s growth more quickly than if it waited for higher profits to expand.

How does a business loan work?

When getting a business loan, a business receives money to use for business expenses or new purchases with the expectation that it will repay the loan.

The lender then charges interest and fees to offset the risk and the costs of lending money. The interest charged can be fixed or variable. With a fixed-rate loan, the interest rates won’t change over the life of the loan, but they can change with a variable-rate loan.

Most business loans also set a fixed amount of time that the loan must be repaid in, called the repayment term.

What is a business line of credit?

A business line of credit offers businesses a set loan amount that they can borrow at any time up to the limit determined by the lender. Businesses can borrow any amount at or under the credit limit. Lines of credit also typically let businesses borrow money repeatedly. It’s ideal for covering last-minute or ongoing expenses, such as managing dips in cash flow.

How does a business line of credit work?

Once your business draws from a line of credit, the repayment term starts and interest is calculated on the amount you borrow. You typically repay the loan on a weekly or monthly basis. Repayment terms can last between six and 24 months for short-term lines of credit or five years or longer for long-term lines of credit.

When you draw funds, your available credit is lowered by the amount borrowed. But it replenishes as your business makes payments, allowing you to draw new funds at any time. In addition to the interest that you’ll have to pay, some lenders charge a draw fee each time you borrow money.

Compare business loans vs. business lines of credit

A business term loan provides funds for a business in one lump sum. Once you’re approved, you start making payments with interest charged right away. But a business line of credit lets you draw funds whenever you need them, only paying interest on the amount you draw.

Let’s look at the differences between getting a business term loan versus a line of credit.

When to consider a business loan

A business loan may work best if you:

• Need a loan for a specific purchase
• Need high loan amounts, such as $500,000 or more
• Want set repayment terms with a defined end date
• Don’t need to use the credit for future purchases

When to consider a business line of credit

A business line of credit may be best if you:

• Want access to credit as needed
• Want to use the line for future purchases
• Need to make small purchases or cover cash flow gaps
• Want to only pay interest on the amount you withdraw
• Can’t qualify for a conventional business loan through your preferred bank

Where to get business loans or lines of credit

You can get business term loans and lines of credit from traditional banks, online lenders and community-based lenders — with each lender offering different benefits.

When comparing loans from each lender, consider that both term loans and lines of credit offer short and long repayment options. For example, short-term lines of credit may offer repayments between six and 24 months. Long-term lines can go as long as five years or longer, and some act similar to a credit card with no set repayment schedule.

Here are examples of different types of lenders where you can get business loans or lines of credit:

Banks

Traditional banks tend to offer low interest rates for a variety of loans, including term loans and lines of credit. They may offer multiple line of credit options, including secured lines for credit-building.

But banks often have strict lending criteria for all of their loan products, such as a credit score of 670 or higher and annual revenue of around $200,000. They may lower requirements for a line of credit compared to a term loan, but the criteria may still be higher than other lenders.

Let’s look at the features of term loans and lines of credit for different banks.

• Bank of America

  Bank of America offers both secured and unsecured term loans in amounts starting from $10,000. Where this bank really shines, though, is with its business line of credit options. You can get an unsecured line with a minimum $10,000 credit limit that doesn’t charge a draw fee. Its secured line offers limits of at least $25,000, but you’ll need $250,000 in annual revenue to qualify. If you’re a startup with six months or more in business, you can go with its credit-builder line as long as you can put down a $1,000 deposit.
  

• Wells Fargo

  Wells Fargo’s business lines of credit are its specialties. It offers three options built for businesses in different growth stages. These include an SBA-backed option for startups, an unsecured line for most other businesses and a secured line designed for businesses with at least $2 million in annual revenue. But you do need a personal credit score of at least 680 to qualify for these lines of credit.
  

• Capital One

  Capital One provides lines of credit, commercial real estate loans and multiple SBA loans. Its line of credit offers borrowing amounts up to $5 million, well above the $250,000 that most lenders offer. But you’ll need at least two years in business and a Capital One business checking account to qualify.
  

Online lenders

Getting approved with online lenders tends to take less time and requires less in terms of revenue and credit score. They’re typically a better fit for startups and business owners with poor credit. But online lenders may stick with short-term loans, and you can expect higher interest rates than traditional banks. Here are examples of what online lenders offer:

• Bluevine

  Bluevine offers a business line of credit with simple interest rates that start at 6.2 percent, low for an online lender that’s on par with traditional banks. You’ll need a FICO score of at least 625 and a hefty $40,000 in monthly revenue to qualify. For 12-month repayment terms, the requirements are a 700 FICO score, three years in business and $80,000 in monthly revenue.
  

• Credibly

  Credibly offers short-term loans, lines of credit and merchant cash advances by direct lending or through lending partners. Its short-term loans have repayment terms of up to 15 months and funds up to $400,000, while the line of credit funds up to $300,000.But some of its loans can get expensive, charging factor rates rather than interest rates. Factor rates get multiplied by the entire loan amount and can quickly add up to high loan fees.

• SMB Compass

  SMB Compass offers at least nine business loans — more options than most online lenders. Its term loans offer $25,000 to $5 million in funding. But you’ll need a strong credit score of 680 and $500,000 in annual business revenue. Its line of credit ranges from $10,000 to $5 million but lowers lending requirements to a credit score of 600 and $100,000 in annual revenue.

Community development financial institutions (CDFIs)

Community development financial institutions (CDFIs) are community-based lenders designed to boost the business outlook of underserved communities. They may accept small businesses with credentials that don’t fit traditional lenders’ standards, such as low revenue or poor credit history. Let’s compare what loan features look like for these lenders.

• Lendistry

  Lendistry provides a range of loan options fit for businesses at different stages. It includes standard term loans, term loans for startups and minorities, a non-revolving line of credit and an SBA loan. But its loan sizes don’t work for small expenses, as they start at $25,000.

• Accion Opportunity Fund

  Accion Opportunity Fund offers term loans from $5,000 to $250,000, focusing on small businesses that can’t traditionally get funding. This includes women, veterans and minority business owners. Interest rates start at 7.49 simple interest for these underserved communities. But it’s not a good fit if your business needs other types of loans, such as a line of credit or equipment loan.

Alternatives to business loans and lines of credit

A traditional business loan may not serve your purpose for financing or be available to you because of your credit history. In these cases, you can try a host of alternatives, such as:

Business grants

Maybe you don’t have the credit history to qualify for a business loan, or you’re a startup without enough revenue to pay back a loan. You could apply for a number of business grants geared to boost small businesses with free capital. Many business grants come from government or private grants from corporations or nonprofits.

But be sure to button up your business plan and put your best foot forward with presenting your business. You may be required to show why your business deserves the grant, such as how your business fills a unique market gap. Grants also aren’t a surefire way of getting business funds because you’re competing with other qualified businesses that applied.

Business credit cards

Plenty of business owners start with business credit cards to bridge small gaps in cash flow. It also gives your business a chance to earn points or cash back, which is useful for travel or small purchases and builds credit for future loans.

The catch is that business credit cards require strong credit, often a personal FICO credit score of 670 or higher. But some business credit cards are geared toward those with fair credit, such as the Spark 1% Classic. You could also choose to get a secured credit card, which requires you to put down a deposit. You may find more secured card issuers that will accept subprime credit, and these secured cards could still help you build your business credit score.

Crowdfunding

Crowdfunding gives you a chance to raise funds for your business either through simple fundraising or by seeking out investors. You can get started by searching for crowdfunding platforms, such as Kiva or Kickstarter.

When using investors, you usually either offer rewards or sell shares of your company, which is known as equity crowdfunding.

Unlike traditional startup financing, equity crowdfunding raises a goal amount through multiple investors that offer small financing amounts. You do have to maintain your reputation and deliver the return that investors are expecting, sometimes called social credit.

Peer-to-peer lending

Peer-to-peer lending can help your business get a loan funded through individuals rather than a financial institution. This type of loan may weave in elements of crowdfunding, such as raising a goal amount before the repayment term starts.

Like crowdfunding, it’s beneficial for bypassing credit requirements. But you may not get as much funding as you would with a business loan. For example, Kiva is a hybrid crowdfunding and peer-to-peer lending platform that caps loan amounts at $15,000.

Invoice factoring

If you have a large number of unpaid invoices but are getting tight on cash flow, you could qualify for invoice factoring. It works by selling outstanding invoices to a factoring company that collects the payments. Your business gets an advance of up to 90 percent of the invoice amount that you can use for any expenses.

Once the factoring company receives payment, it takes out fees and pays your business the remainder. Fee structures can vary but are usually charged as a percentage of the total amount borrowed.

Merchant cash advances

Merchant cash advances forward capital to your business, using your past credit or debit sales as a basis for approval. One upside is that you get payment flexibility with percentage-based payments, paying off the advance as quickly or as slowly as your sales allow.

Another perk is that most MCAs don’t require strong credit or revenue to qualify. This makes it an ideal option for startups with steady sales revenue and business owners who need a bad credit business loan.

You usually make payments daily or weekly, either from a percentage of sales or as a fixed payment. MCAs are helpful for fast funding and are accessible to many businesses. But the aggressive repayment schedule can eat into your sales profits until it’s repaid.

Bottom line

Many business owners go with a business term loan or line of credit to access the funding they need. While there are similarities, most businesses use term loans for one-time funding and repay over the course of several years. Short-term loans are available with terms as short as six months.

Meanwhile, businesses get approved for a line of credit with a set borrowing limit. They can borrow from that amount at any time, which is helpful for emergencies or small expenses. To make a decision, review the loan features with different lenders and prequalify to see what rates and terms you can get.

Frequently asked questions

• Is it easier to get a loan or line of credit?

  Business lines of credit tend to have easy qualifications, such as requiring a lower credit score compared to business term loans. Ultimately, it depends on the lender since each lender sets its own qualifications.

• What credit score do I need to get a business line of credit?

  You can get a business line of credit with a personal credit score of 600, typically through an online lender. But if you’re going with a traditional bank or credit union, it requires a score of 670 or higher to qualify.

• Why are some businesses more attracted to lines of credit vs bank loans?

  Lines of credit are more attractive than other loans because businesses can borrow from the credit line repeatedly. Once approved, they can borrow funds any time they need financing up to the preset credit limit.