Small businesses sometimes need a little extra financial help to get through a rough patch or make a big purchase. In fact, 30% of small businesses fail because they run out of money.
Your business doesn’t need to end up included in that statistic with all the lending options out there. A small business loan or a line of credit might be just what you need to stay afloat.
Learn the difference between business loans and lines of credit below to figure out your best option.
What Is a Small Business Loan?
A business of any size can take out a business loan, not just small businesses. A business loan is also known as a term loan. It refers to when you borrow money in a lump sum and then pay it back over a fixed period of time.
The fixed period of time to pay back the lender, known as the term of the loan, ranges anywhere from a year up to 20 years.
Business Lending: How Does a Term Loan Work?
A term loan works similarly to a mortgage. You receive all the funds at once and then pay back the principal plus periodic interest. Business loan interest payments usually occur monthly, but some lenders allow more frequent payments.
The majority of term loans come amortized, meaning with a fixed interest rate for the entire life of the loan. Others come with balloon payments or interest-only payments.
Business loans also come with a closing fee that you need to pay separately and upfront. You never receive this fee back. The closing fee might be a percentage of the loan or a lump sum.
Term loan lenders require you to show exactly what you plan to use the money for and how the money will help your business profit. They check this to ensure you’ll make enough money to repay the loan.
You’ll generally need to use business assets as collateral to secure a term loan. This could mean equipment, inventory, or real estate. Once you gain a reputation for repaying loans, lenders may offer your business unsecured term loans.
Not everyone is interested in a fixed rate, however. Sometimes the market can change and you get stuck paying higher interest payments than necessary. In those cases, you’re better off with a variable rate loan.
Benefits of a Business Loan
A small business, or term, loan works the best for long-term investments. It allows you to get a large, lump sum of money quickly. It can take between 24 hours up to a week for approval depending on the lender.
A term loan also guarantees your interest rates for the length of the loan. So if you know interest prices are slowly increasing in your industry, it makes financial sense to secure a lower rate.
Choose a small business loan if you need working capital to buy fixed assets like expensive equipment requiring several years to repay. It’s also preferred when doing construction or buying another business.
Older businesses with good track records of repayment should also choose these kinds of loans. Not only do lenders prefer working with a reputable business, but they may also let you borrow without collateral.
A term loan also makes the most sense when you look at it from an accounting perspective. The smart way to pay for a long-term asset with long-term costs is to repay it with long-term liabilities.
For example, that new piece of equipment might not pay itself off in a year, but in 10 years. So it makes sense that you only pay a portion of the cost in a 10-year fixed-rate loan as the equipment pays for itself.
Business Finance: What Is a Line of Credit?
A line of credit, on the other hand, resembles a cash advance on a credit card rather than a mortgage. A business line of credit is a revolving loan where you get access to funds up to a certain limit whenever you want. You then repay the amount borrowed with flexible repayment terms.
Don’t borrow the entire amount at one time? You may borrow more (up to the limit) as long as you continue to make minimum payments.
The interest rate on an operating line of credit varies over time, unlike a term loan. However, if you do not borrow anything on the line of credit, you never owe any interest. Keep in mind if you miss even a single payment, your interest rate will increase dramatically.
A line of credit may come secured or unsecured. If you’d prefer an unsecured loan be prepared to prove the profitability of your business and your current cash flow.
Benefits of a Line of Credit
An operating line of credit works best for fast, short-term cash needs. This includes seasonal expenses, payroll, temporary cash flow shortages, and unexpected payments. You can get the money immediately without waiting for approval like with a business loan.
A line of credit also has lower or no closing costs as compared to a term loan. You can pay down and withdraw more funds as many times as you want without any extra costs.
Newer businesses with established cash flow can also get a line of credit without collateral much easier than a term loan without it. That limits the risk to your business.
A line of credit also allows you to repay the borrowed amount with greater flexibility since you only need to pay the minimum no matter how much you borrow. With a term loan, you put the loan in jeopardy if you can’t meet the monthly payment.
You wouldn’t want to use a line of credit for a long-term project, however, because then all the funds get tied up in that project.
Apply for Business Funding Online for a Quick Business Loan
A business loan and a line of credit have their appropriate purposes. Once you understand how they both work, you can figure out which one better fits your business’s needs.
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