About 50% of businesses don’t survive past the five-year mark for lack of capital. Most of them haven’t established a line of credit or loan source by this time. If they have, they’re unable to keep up with the requirements for one reason or another.
If you’re looking for a source of capital to expand your business, consider a line of credit vs loan term. It’s essential that you understand the difference before you settle for either. Each has its terms and conditions, as well as advantages and disadvantages.
Let’s now delve into a line of credit vs loan, what each entails, and how they differ.
What’s a Line of Credit?
A business line of credit shares the same characteristics as a personal line of credit such as credit cards. It refers to a loan that you can use over and again. It allows you to borrow up to a given limit, make minimum payments and pay interest.
Once you clear off the balance, you can borrow again. The borrowing can happen as many times for as long as the line of credit is open and in good standing.
You can use funds from a line of credit using a card tied to the account or by writing checks. Alternatively, you can request a transfer of the funds to your checking account. One good thing with a line of credit is that you don’t incur interest until you’ve tapped into the funds.
Lines of credit come in two forms: secured and unsecured. Secured lines of credit require that you provide some valuable asset as collateral or some personal guarantee. Whatever you offer as security, you promise the lender to repay the loan.
In case you’re unable to repay it, the lender can use the collateral to recoup the loss. With a secured loan, you get more favorable loan offers for a longer extended period.
Unsecured lines of credit don’t require you to offer any collateral for the loan. You can avoid the risk of putting valuable assets on the line. In return, the lenders charge higher interest to make up for the increased risk.
For the unsecured lines, there’s a limit to the number of times you can access funds. Usually, they also serve you for a few years, after which you must repay every amount due.
Qualifying for a Line of Credit
Sometimes, you’ll find that you don’t qualify for a line of credit. In most cases, this happens when you don’t have the best credit history. In this case, it might be easier for you to get a personal loan you can qualify for, but at a higher interest rate.
If your debt on lines of credit piles up, you may also not qualify for funds. If you only make minimum payments and interest, you’ll soon not qualify for the line of credit.
Some of the situations that can prompt you to apply for a business line of credit are:
- When you’re not sure how much money you’ll need
- You project your expense to spread some years
- You’ve got a good credit position
Before you consider applying for a line of credit, check to see whether you can repay the funds reasonably.
What’s a Term Loan?
A term loan is where you borrow a lump sum of money, payable over a specified period. Unlike a line of credit, which is renewable, a term loan is fixed for the amortization period. Most lenders prefer to extend collateralized loans, but this is not always possible.
When selecting a term loan, you can choose from among the many available repayment periods. You can also choose to have a fixed or viable interest rate. Be sure to compare the rates before signing up for the term loan.
The downside of a term loan is that you start repayments immediately, even if you haven’t used the fund yet. The costs of acquiring the loan and the interest rates are also typically higher than for a line of credit. Upon using up the loan amount, you’ll have to reapply for a new loan in the amounts you need.
Term loans are in three primary forms, classified as long, medium, and long-term. The long-term loans have multi-year terms and repayments are done monthly. Medium-term loans are more prolonged than short-term loans but shorter than long-term ones.
They’re more expensive than bank loans.
Short-term loans are the most popular, usually extending to between 3 and 18 months. Repayments are made daily or weekly, and they can be quite expensive in the long run. The credit requirements for short-term loans are less stringent but can significantly impact on your cash flow.
Qualifying for a Term Loan
Figuring what you need to qualify for a business loan will save you a lot of headaches later. Unlike with a line of credit, you’ll need to have a good credit score to qualify for a loan. If your credit scores are below acceptable, work on improving them before loan application.
One of the crucial things to do is develop a habit of paying your bills on time. For any outstanding loans, get into the habit of repaying them on time.
Check the lender’s minimum qualifications. Meeting them will make you a more favorable applicant. Some lenders will try to balance your weak and strong financial areas, but the best thing is to exceed the entire required minimum.
Once you’ve checked the qualifications, put your financial and legal documents together. Lenders typically ask for documents like the following:
- Business and personal income tax returns
- Income statement and balance sheet
- Business bank statements
- A copy of your driver’s license
- Articles of incorporation
- Commercial Leases
- Business licenses
- Any financial projections
Putting together these documents can take time and hence make getting a loan time-consuming. This is when you may want to consider a line of credit if you need the money for an urgent need.
Line of Credit vs Loan
Choosing between a line of credit vs loan is a decision that calls for a lot of scrutiny. You need to decide in advance which the best option is for your business. For example, if you need some quick cash for an emergency, your best option would be a line of credit.
You can also consider a short-term loan. Both options have a fast application process, letting you receive funds in a few days.
One of the best ways to decide is the purpose of the funds you seek. If you need funds for a big project, you’re better off with a long-term loan. You can calculate the cost of investment before taking the loan and determine the ROI on your business.
Advantages of Line of Credit
A line of credit offers some benefits over a term loan.
When it comes to monthly repayments, a line of credit offers some great flexibility. You can make the minimum payment due, pay the full amount, or any amount in between. Most importantly, ensure to pay the interest on the balance you carry.
Secondly, a line of credit offers variable interest rates. If the interest rates go down, it can be your cheapest source of financing. A line of credit also has no fixed terms like there are with a term loan.
In most situations, a line of credit doesn’t factor in your credit score. This means that even with a bad rating, you still have a chance of getting funds.
Advantages of a Term Loan
Term loans are ideal when you need a large amount of money. It comes in handy when you want to make one-time purchases or investments.
You can reapply for a term loan once you finish repaying the current one. If your repayment history is good, you stand a better chance of qualifying for another one. With a line of credit, there’s a time limit within which you can access the facility.
Once this time lapses, you’ll be required to pay off all outstanding balance and interest.
Loans are more cost-effective than a line of credit. If you know all your loan costs upfront, a loan will allow you the flexibility to plan for monthly payments and repayment costs. Timely repayments will help you avoid unexpected interest from accumulating on your loan.
Sometimes in the line of business, you’ll run short of funds to keep operations running. This is where you might find yourself debating over a line of credit vs loan acquisition. When making the decision, think of the costs involved and the benefits each one offers.
A line of credit ensures you have a recurring source of income for a specific time. It also charges you zero interest if you don’t use the funds availed to you. If you keep good standing with your lender, you might have your credit period extended.
With a term loan, there are many requirements involved. The lender will also check your credit score and business records. In the long run, bank loans will cost you more than a line of credit.
Whatever the decision you make for your business financing, ensure it’s an option you can afford.
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