What is the difference between a loan and a line of credit?

Choosing the right financing solution for your business makes a big difference when it comes to managing cash flow and staying on top of your financial goals. It’s important to understand the differences between term loans and lines of credit so that you can make informed decisions for your business. Both options offer access to additional funds, allowing your business to take advantage of growth opportunities and continue running smoothly despite cash flow irregularities. In this blog post, we’ll discuss these two types of financing alternatives so you can determine the best option for the success of your business.

What is a term loan and when does it make sense?

A term loan is a sum of money that is repaid in regular installments over several years. It includes both the principal amount and an interest rate that can be fixed or vary throughout the term of your loan. You can obtain a term loan from various sources such as banks, credit unions, or even friends and family. However, be mindful of predatory lenders who may charge excessively high interest rates, making it challenging to repay the loan.

Term loans often make sense when you are making a one-time purchase, investing in improvements, or looking to refinance debt. If you need to invest in a fixed asset, such as property, equipment, software, or the acquisition of another company, you will want to take a hard look at your term loan options. A term loan will provide you with a reliable and predictable payment plan spread over a period of time that will help you manage your overall operating costs.

What is a line of credit and when does it make sense?

A line of credit is a revolving credit facility that allows you access funds, up to a maximum set amount, whenever you need it. You pay interest on the amount you borrow, and the credit line replenishes as you pay it back. A line of credit generally features a variable interest rate. One benefit to a line of credit is that you aren’t paying interest on money that you have available but have not borrowed yet.

A business line of credit is similar to a credit card with a couple of exceptions. Lines of credit generally have a higher credit limit and a lower interest rate. They can also be structured to make interest-only payments for a set time period with the full balance due at the end of the term. When the end of the term arrives, you have options to close the line of credit, renew it, or roll it into a term loan.

A line of credit is ideal for short-term operating expenses and maintaining liquidity. As a business, you might have seasonal fluctuations in revenue that require extra working capital to sustain cash flow. A line of credit gives you immediate access to funds when you need it, reducing the risk of missing out on business opportunities or having to rely on more expensive short-term borrowing options. Lines of credit are often used to finance accounts receivable,  inventory purchases, payroll, taxes, or unexpected expenses.

Conclusion

Ultimately, the decision to choose either a term loan or line of credit depends on your current financial situation and the specific needs of your business. Term loans are suitable for long-term investments, while lines of credit are best suited for short-term operational needs. CrossFirst Bank was formed to serve the needs of business owners, professionals, and their families. We recognize that every client is unique and one size does not fit all when it comes to business financing. With that in mind, we offer solutions based on the dynamic needs of your business. Remember to always consult with our banking experts to determine which financing option is right for you.