Lines of credit and term loans are the two most common financing products for small businesses, but they work very differently. Choosing the wrong one can mean overpaying for capital you do not need, or being locked into a rigid structure when your business needs flexibility.
This guide breaks down both products in detail so you can make an informed decision.
The Core Difference
A term loan gives you a lump sum of money upfront. You repay it in fixed installments over a set period. Once you receive the funds, the loan is fully disbursed. If you need more capital later, you apply for a new loan.
A line of credit gives you access to a pool of capital that you can draw from as needed. You only pay interest on what you use. As you repay, that credit becomes available again. It is revolving, like a credit card, but with better rates and higher limits.
Side-by-Side Comparison
| Feature | Line of Credit | Term Loan |
|---|---|---|
| Structure | Revolving, draw as needed | Lump sum, fixed payments |
| Funding amount | $1K - $10M | $50K - $300K |
| Interest | Pay only on drawn balance | Pay on full loan amount |
| Repayment | Revolving, up to 36 months | Fixed monthly, 2-5 years |
| Speed | Under 1 week | 1-2 weeks |
| Credit requirements | More flexible (no minimum at some lenders) | Moderate (typically 600+) |
| Collateral | Usually not required | Usually not required |
| Best for | Ongoing working capital needs | One-time investments with clear ROI |
When a Line of Credit Is the Better Choice
A line of credit is designed for ongoing, recurring capital needs where the timing and amount are not perfectly predictable.
Use Cases
- Managing cash flow gaps: Revenue comes in cycles, but expenses do not. A line of credit bridges the gap between when you pay suppliers and when customers pay you.
- Seasonal inventory purchases: Retailers and wholesalers who need to stock up before peak seasons can draw on their line, sell the inventory, repay, and repeat.
- Unexpected expenses: Equipment breaks, a key employee quits and you need to hire quickly, or a customer payment is delayed. A line of credit means you do not scramble for capital in an emergency.
- Taking advantage of opportunities: A supplier offers a bulk discount, or a new contract requires upfront investment. Having a line of credit means you can move quickly.
- Building business credit: Responsibly using and repaying a line of credit builds your business credit profile, which opens up better financing options in the future.
Think of it this way: If you cannot predict exactly how much capital you will need or when, a line of credit gives you the flexibility to respond. You do not pay for capital sitting idle.
When a Term Loan Is the Better Choice
A term loan is designed for specific, one-time capital needs where you know the amount and the purpose upfront.
Use Cases
- Equipment purchases: Buying a new truck, commercial kitchen equipment, or manufacturing machinery. The loan amount matches the purchase price, and the repayment schedule is predictable.
- Business expansion: Opening a second location, renovating your space, or scaling operations. These are defined projects with defined costs.
- Hiring and training: Bringing on new employees to fulfill a large contract or enter a new market. The investment is clear, and the expected return justifies the fixed cost.
- Debt consolidation: If you have multiple high-rate debts (merchant cash advances, credit cards), a term loan at a lower rate can consolidate them into one manageable payment.
- Technology or infrastructure: Software systems, IT upgrades, or facility improvements that have a one-time cost.
Think of it this way: If you know exactly how much you need and what it is for, a term loan gives you the capital at a fixed cost with no surprises.
Cost Comparison
The total cost of each product depends on how much you borrow, for how long, and at what rate. But the structures affect cost in important ways:
Line of Credit
- Interest accrues only on your drawn balance, not the full credit limit
- If your limit is $100K and you draw $30K, you pay interest on $30K
- Some lines charge a maintenance fee or unused line fee (typically 0.25-0.5% annually on the unused portion)
- Rates tend to be slightly higher than term loans because of the flexibility
Term Loan
- Interest accrues on the full loan amount from day one
- Payments are fixed and predictable, which makes budgeting straightforward
- Many term loans have no prepayment penalties, so you can pay them off early without extra cost
- Rates are typically lower than lines of credit because the lender has a fixed repayment commitment
Example: A business borrows $100K. With a term loan at 10% for 3 years, total interest paid is roughly $16K. With a line of credit at 12% where the average drawn balance is $50K over 12 months, total interest paid is roughly $6K. The line of credit costs less in this scenario because you only used half the capital on average.
Can You Have Both?
Yes, and many businesses do. It is common to use a term loan for a specific investment (equipment, expansion) while maintaining a line of credit for ongoing working capital. The two products serve different purposes and complement each other well.
For example, a restaurant owner might use a $150K term loan to renovate their dining room and a $50K line of credit to manage cash flow during the slow season. The term loan covers the project; the line of credit covers day-to-day operations.
Qualification Differences
Lines of credit are generally easier to qualify for than term loans because the amounts tend to be smaller and lenders have the flexibility to adjust your limit based on risk.
| Requirement | Line of Credit | Term Loan |
|---|---|---|
| Time in business | 6+ months | 1+ year preferred |
| Monthly revenue | $10K+ | $15K+ typical |
| Credit score | No minimum at some lenders | 600+ typical |
| Documentation | Bank statements (3-6 months) | Bank statements + financials |
How to Decide
Ask yourself these questions:
- Do I know exactly how much I need? If yes, term loan. If not, line of credit.
- Is this a one-time expense or an ongoing need? One-time: term loan. Ongoing: line of credit.
- Do I want predictable fixed payments? Term loan gives you that certainty.
- Do I want to minimize interest cost? If your usage will vary, a line of credit lets you pay interest only on what you draw.
- Do I need capital today or access to capital over time? The answer determines which product fits.
Not sure which one fits? Start your application with Halford Capital and we will match you to the right product based on your business profile and funding needs. One application covers both products.