Term loan vs line of credit: What’s right for your business?
Choose the right loan to give your business the financial boost it needs.
Whether to expand, get off the ground or just to provide a little support, many businesses need the help of a loan at some point. But while banks and lenders advertise their special rates and exclusive features, the most important thing to consider when choosing a loan is the type that will best suit your company. Here, we take a look at the two main options: a term loan and a line of credit.
Line of Credit
Providing a single, lump-sum payment, this is the most straightforward and most common loan available. You will have an agreed period of time in which to pay the loan back and will be required to pay interest on the entire loan amount even if you don't use it all. Once you have spent all the available funds, you’ll need to apply for a drawdown or start again with a new loan.
Features that come with a term loan
- Fixed or variable rate of interest. Many banks will let you choose between a loan with a set interest rate and one that fluctuates with the market rate.
- Flexible repayment plans. Some loans offer redraw facilities that allow you to choose exactly how much you pay back and when. Such features are often used as an incentive to go with a variable rate of interest.
- Discounted rates. In return for paying interest on a sizable loan, lenders regularly offer discounts for a limited time.
Who is this type of loan suited to?
A term loan will suit the small business that has a clear figure it needs to cover outgoings over a fixed period. As a single amount, it’s useful for making specific purchases where the price is known in advance. Some kind of cash flow will still be necessary to cover interest and additional fees.
Line of credit loan
Also known as an equity loan, a business line of credit is similar to an overdraft facility as you only pay interest on funds that you use. Interest is paid monthly but there is no set time for when the loan needs to be fully repaid. Early and extra repayments are usually accepted with the option to redraw if the need arises.
What are the features of a line of credit loan?
- No repayment requirements. As long as the account remains in good standing as per the terms of the account there is no set amount for monthly repayments.
- Option to increase the maximum loan amount. The total funds available can be increased in line with the needs of your company.
- Withdrawals can be made at any time. You're able to withdraw up to a daily or card limit at any time, making it a convenient option for business owners.
Who is this type of loan good for?
The flexibility and reflective interest payments with a line of credit loan make it a cheap and efficient way to finance a company for a short time. It can cover differences in income and outgoings produced by a variable payroll or increased expenses at a certain time of year.
Business loans you can apply for
How can you get your company a loan?
The processes involved in finding approval for a term loan are simple. The lender will want historical evidence of successful cash flow and assurance of collateral, should your company be unable to repay the loan.
The prerequisites for a line of credit are similar but more stringent. Along with a written guarantee of repayment, lenders will provide a list of rules that must be kept in order to continue with the loan. These covenants will usually involve the company maintaining a certain net worth and not dropping below an agreed level of debt.
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