When your business needs capital, two options come up again and again: a business line of credit and a term loan. They sound similar but solve different problems, and using the wrong one is an expensive mistake. Here is how each works and how to choose.
What is the difference between a line of credit and a term loan?
A term loan is a lump sum you repay on a fixed schedule; a line of credit is a flexible limit you draw from as needed. That difference drives everything else:
- Term loan: you receive the full amount up front and repay it in regular installments over a set period, usually at a fixed rate. Predictable, good for a known one-time cost.
- Line of credit: you are approved for a maximum, draw only what you need, pay interest only on what you use, and the credit replenishes as you repay. Flexible, good for recurring or uncertain needs.
When should I use a term loan?
Use a term loan for a specific, one-time investment with a clear cost and a long-term payoff. It is the right tool when you know exactly how much you need and the purchase will generate value over years. Classic uses include buying equipment or a vehicle, financing a build-out or expansion, or acquiring another business. Because the payment is fixed and predictable, a term loan is easy to budget around, and matching the loan term to the useful life of what you are buying keeps the financing sensible.
When should I use a line of credit?
Use a line of credit for short-term, recurring, or unpredictable cash needs. It shines at smoothing the gaps rather than funding a single big purchase. Good uses include covering payroll during a slow stretch, bridging the wait on customer payments, buying inventory ahead of a busy season, or handling an unexpected expense. Because you pay interest only on what you draw, a line of credit is an efficient safety net — and for contractors waiting on invoices or retainage, it can be the difference between making payroll and missing it.
Which is cheaper?
It depends on how you use it, not just the rate. Term loans often carry lower rates but you pay interest on the whole balance for the full term, even money you did not urgently need. A line of credit may have a higher rate, but if you draw small amounts briefly, your actual interest cost can be lower. The expensive mistakes are using a line of credit to fund a long-term purchase you then carry indefinitely, or taking a big term loan for a short-term gap you could have covered with a draw. Matching the tool to the need is what keeps the cost down. Our Business Optimization team helps owners structure financing that fits.
What do lenders look at for either one?
Your financials, your credit, and your ability to repay. For both products, lenders typically review your business and personal credit, your revenue and cash flow, time in business, and often your financial statements and tax returns. Clean, current books make a real difference here — they let a lender see your true cash flow and approve you faster, sometimes at better terms. Businesses that keep their financials in order tend to get more financing options, which is one more reason good bookkeeping pays off long before you apply.
Can I have both a line of credit and a term loan?
Yes — many businesses use both, because they solve different problems. A term loan can finance a major purchase like equipment or a build-out, while a line of credit sits alongside it as a flexible cushion for payroll gaps, inventory, and the timing of customer payments. Using each for what it does best is smart financial management, not over-borrowing. Lenders generally have no issue with a business carrying both, as long as your cash flow supports the payments. The key is to match each tool to the right need: long-term assets on the term loan, short-term swings on the line of credit, so you are never paying long-term interest on a short-term need or straining a credit line to fund a permanent purchase.
Choosing the right financing is as important as getting approved. If you want help deciding which fits your situation — and getting your numbers ready — we are glad to help.