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Updated: April 13th, 2020
Figuring out how to finance your business is just one of many learning curves involved in entrepreneurship.
Oftentimes, small business owners find themselves evaluating terms loans vs. lines of credit.
But, when you’re researching your funding options, everything from merchant cash advances to venture capital can seem equal parts exciting and confusing.
To help you choose the option that best suits you and your business’ needs, we’re breaking down two common forms of business financing: term loans and lines of credit.
With a term loan, you borrow a set amount of money and pay it back over a set period of time. Once you’re approved for the loan and your interest rate is determined, you’ll receive the entire lump sum at once and start making repayments on a predictable monthly schedule.
Terms loans might have a fixed interest rate, where your rate remains the same over the course of the term, or a variable one, where your rate may change depending on the financial market.
Depending on the lender, you could receive a term loan that gives you a fixed amount anywhere from $25,000 to $1 million for a period of one to 10 years.
(For more info, check out our in-depth guide on term loans)
A line of credit, on the other hand, gives you access to a specific amount of money (which could range from $5,000 to $1 million or more) that you can dip into on an ongoing basis.
Much like a credit card, you don’t make payments or rack up interest until you actually use your funds. And unlike a term loan, you can use your funds repeatedly as long as you pay them off.
If you use your entire $25,000 line of credit, for example, then bring your balance back down to zero, you’ll have access once again to the entire $25,000.
Though lines of credit often have interest rates comparable to those of term loans, keep in mind that the rate you get may be variable and can skyrocket if you miss a payment or go over your limit. (For more info, check out our in-depth guide on lines of credit)
Before you decide which direction to go for funding, it’s important to consider your business needs.
A line of credit works best for:
Imagine, for example, that you own a graphic design business and need to issue out yearly bonuses to your employees by the end of the week. Your client invoices, however, won’t be completed until the start of next week — that’s where a line of credit comes in handy.
In short, the money from a line of credit is designed to give you increased financial flexibility, which is why it’s important not to tie up your funds by paying off long-term investments.
A term loan, on the other hand, works great for:
The best part of a term loan is that it can give you the freedom and financial security to move forward with big purchases, while also providing the structure necessary to stay on track with your payments.
When it comes to term loans, Funding Circle stands out for our ease and efficiency. It takes just a few minutes to apply, and you can get a decision in as little as 24 hours.
The most creditworthy applicants receive fixed rates competitive with traditional bank loans, and because we believe in an honest, transparent borrowing experience, you’ll know exactly how much you have to repay each month — no need to worry about variable interest rates or hidden fees. Plus, unlike some other lenders, we don’t have a prepayment penalty. That means you’re free to pay off your loan as quickly as you’d like!
Paige Smith is a Content Marketing Writer and Senior Contributing Writer at Funding Circle. She has a bachelor's degree in English Literature from Cal Poly San Luis Obispo, and specializes in writing about the intersection of business, finance, and tech. Paige has written for a number of B2B industry leaders, including fintech companies, small business lenders, and business credit resource sites.