Should You Get a Business Loan or Business Line of Credit?
If the past two years taught us anything about saving money, it’s that business survival requires having a substantial cushion in case the unimaginable happens—like a global pandemic. So when your business needs money, what’s the first business loan solution that pops into your mind? Most business owners think a business loan is the answer when another financing solution like a business line of credit would most likely better suit the situation. But how do you know which type of financing is actually right for your business? Here’s some background to help you make an informed decision.
What is a Business Loan?
Getting a small business loan is similar to getting a consumer loan. However, typically, business loans have more conditions that need to be met before the lender approves the loan. Also, business loans require considerable documentation during the application process, such as asking the small business owners to put up collateral and submit a business plan.
Traditional term loans, such as business loans from a bank or credit union, are granted to business owners as a lump sum and (depending on the type of loan) have a fixed or variable interest rate. Also called an installment loan, term loans mean borrowers make monthly payments and pay interest within the term limit of the loan—usually from six months to five years. Short-term business loans work similarly; however, they are typically for less money and need to be paid in full within 12 months.
Business loans also may have more restrictions on where the loan money can be spent. For example, the funds must be used for business purchases, such as inventory, business utilities, transportation, new equipment, etc. Sometimes, lenders may place even more limitations on certain business loans, such as the loan can only be used on real estate or office renovation.
Interest rates for business loans vary by lender, location, and business credit scores. Small business owners looking for a business loan should first check out the loans offered by the lenders working with the Small Business Administration (SBA). SBA-guaranteed loans are available from SBA-approved lenders and feature more flexible terms and lower interest rates.
Borrowers can apply for SBA loans from under $10,000 to $5 million if the small business meets the qualifications. There are several types of SBA loans, including:
- SBA 7(a) Loan: The most common SBA small business loan program, borrowers must prove that personal resources and other financing have been sought before applying for the 7(a) loan. The maximum loan amount is $5 million.
- SBA Express Loan: SBA Express Loans are part of the 7(a) loan program, and the maximum loan amount is $500,000. Lenders are required to review the loan application within 36 hours, and like the regular 7(a) loan, applicants must have already invested personal resources in the business. Also, a FICO score of 650 or above is preferred, and the company must show two years of business income.
- SBA 504 Loan: This loan is available for long-term, fixed-rate financing of up to $5 million. The loan restricts use for “major fixed assets that promote business growth and job creation.” The money can’t be used for debt refinancing, working capital, or inventory purposes.
- SBA Microloan: Microloans are maxed out at $50,000 and are available through nonprofit community-based organizations/lenders. The lenders set the lending and credit conditions, and collateral is required.
Business loans are also available from online lenders. These typically have fewer restrictions than bank loans. However, online business loans usually come with higher interest rates and fees because the risk is higher for the online lender.
What is a Business Line of Credit?
As with a business credit card, a business line of credit is a “revolving” credit line that allows the borrower to draw money when needed and pay it back over time. Also, like a business credit card, the borrower is preapproved for a specific credit limit and only pays interest or fees on the amount drawn. Then once the draw has been paid back, there are no fees to pay until the next draw.
For businesses, especially small businesses, a business line of credit can be the life preserver they need to save the company during a cash flow crisis or for unforeseen business expenses. A small business line provides the small business owner with access to vital working capital for as long as the business line of credit is available under the preset term limits. For example, a business line of credit might be a better solution when companies find themselves struggling through a slow sales season or lacking the cash to purchase an essential piece of equipment.
How does the business line of credit work? First, borrowers submit an application, and then after approval, the loan is set aside in a separate account, ready to be accessed whenever the borrower has a business need. The withdrawn portion of the loan then accumulates interest (plus any fees). Once the withdrawn amount is repaid, the entire loan is available again to borrow from without necessitating another loan application.
If your company has a relationship with a particular business bank, it’s often best to begin by talking to the loan officer there about a business line of credit. Ask about fees and application requirements to compare terms with other lenders. Alternative online lenders also offer business lines of credit and typically have fewer qualification restrictions; plus, your company may be approved much quicker. Still, it’s essential to compare rates and fees before committing to any business loan.
3 Differences Between a Business Loan and Line of Credit
A small business line of credit differs from traditional business loans in many aspects, but typically in three important ways: requirements, repayment schedules, and funding size.
Requirements: As previously stated, applying for business loans usually requires more qualifications and documentation than business lines of credit. The information and documents list can be quite extensive depending on the lender. Here is a list of what you may need to submit:
- Resumes of owners and key management personnel
- Updated business plan, including the budget plans for the business loan
- Most recent business credit report (the lender pulls this for you)
- Most recent personal credit report. If the business does not have an extensive credit history, the lender may pull the owners’ credit reports.
- Three years of business income tax returns
- Business financial statements (balance sheet, income statement, cash flow statement, and bank statements)
- Accounts receivable and accounts payable
- Collateral includes assets the lender can possess and sell in case of default
- Legal documents such as business licenses and permits, articles of incorporation, contracts with third parties, etc.
- Federal Tax Identification Number or Employer Identification Number (EIN)
For business lines of credit, the requirement list also varies by lender:
- Recent business tax returns
- Recent personal tax returns
- Bank account information and bank statements
- Financial statements (balance sheet, income statement)
- Federal Tax Identification Number or Employer Identification Number (EIN)
- Social Security Number
- Business entity type (sole proprietorship, partnership, corporation, limited liability company)
- Past loan documentation
Repayment Schedule: Business loans are considered installment credit, which, as mentioned above, means the loan is given to the borrower in one lump sum. The borrower pays fixed monthly payments, including principal and interest until the loan is paid in full. Because a business line of credit is revolving credit, as the money is repaid, the money is available to borrow again without applying for a new loan. Lenders typically require monthly or bi-monthly payments, but because the amount drawn is usually not the total amount of the loan, the installments are smaller, and the withdrawn amount is paid back quickly.
Funding Size: The funding size for business loans and business lines of credit vary by what a company can be approved for, by need, and by the lender. Business loans are generally larger and are made for specific large purchases or projects. Business lines of credit tend to be smaller and used for working capital purposes, such as repairs or meeting payroll.
Need Help Financing? Contact Financing Solutions Today!
With the Financing Solutions Business Line of Credit, nonprofit organizations always have the benefits of a more straightforward application process, plus:
- There are no costs to set it up or keep it in place
- There’s an easy 2-minute application online application
- If approved, you’ll receive a same-day, no-obligation offer letter
- The fastest setup, 48-72 hours
- Once you get the line of credit, requests for funds are wired to your bank in minutes
- You can use your line of credit whenever needed
- Inexpensive when used (low fees)
- There are no restrictions in place or collateral required
- No personal guarantee is required, either
- Financing Solutions is a leading provider of lines of credit
- We are a reputable company with an A+ & 5-star rating
- You can pay off the line whenever you are ready
- The credit line renews yearly and is easy to renew
- You have a secured account portal access 24 x 7
A line of credit is a good funding resource that’s available whenever your company needs it, without the heavy burden of term loan requirements. If you want to see if your business would be approved and for how much, please fill out the no-obligation, 2-minute line of credit application here. Contact us today!