Term loans and lines of credit are the two most common types of business financing, and business owners mix them up all the time. Both give you access to capital. But they work very differently, and the right choice depends on one simple question: do you know exactly what you're paying for, or do you need money on standby?
How a Term Loan Works
A term loan gives you a lump sum of money upfront. You repay it in fixed installments over a set period, usually anywhere from 6 months to 5 years for most small business term loans. Your payment stays the same, so it's easy to plan around.
Term loans are built for one-time investments with a clear price tag:
- Opening a second location
- A major renovation or build-out
- Buying out a partner
- Paying off higher-cost debt
- A large inventory purchase for a big contract
How a Line of Credit Works
A business line of credit gives you a credit limit you can draw from whenever you need it. You only pay for what you actually use, and as you repay, that amount becomes available again. Think of it like a business credit card with a much higher limit and better terms.
Lines of credit are built for expenses that come and go:
- Covering payroll while you wait on customer payments
- Seasonal dips in revenue
- Restocking inventory on a rolling basis
- Unexpected repairs or emergencies
- Jumping on a supplier discount when it shows up
Side by Side
- How you get the money: Term loan is one lump sum. Line of credit is draw as needed.
- What you pay for: Term loan charges on the full amount. Line of credit charges only on what you've drawn.
- Payments: Term loan payments are fixed. Line of credit payments go up and down with your balance.
- Reusable: A term loan is not. A line of credit refills as you repay.
- Best for: Term loans fit planned, one-time investments. Lines of credit fit ongoing cash flow needs.
The Most Common Mistake
The most expensive mistake we see is using a term loan for a cash flow problem. If you borrow $100,000 as a lump sum to cover slow months, you're paying for all $100,000 from day one, even if you only end up needing $30,000. A line of credit would have cost you a fraction of that.
The reverse mistake happens too. Using a line of credit to fund a big, long-term project can leave you with a maxed-out line and nothing left for actual emergencies.
Can You Have Both?
Yes, and many established businesses do. A common setup is a term loan for a specific growth project plus a line of credit kept open as a cushion. As long as your revenue supports both payments, it gives you a plan and a safety net at the same time.
What You Typically Need to Qualify
Requirements vary by program, but most term loans and lines of credit look at the same basics: time in business (often 6 months or more), steady monthly revenue, your recent business bank statements, and your credit profile. Lines of credit sometimes ask for a slightly stronger credit score because the funds are reusable.
The Bottom Line
If you know exactly what you're buying and what it costs, a term loan usually makes more sense. If you need flexible access to cash for expenses that come and go, a line of credit is usually the better fit. Not sure which describes your situation? That's exactly the conversation a good funding advisor should have with you before you apply for anything.
Not sure which one fits?
Apply once and a HeyFunder advisor will walk you through both options. No hard credit pull to see where you stand.