Loans and lines of credit can get a little confusing. You know that they both involve your company getting money, but how do they work and what are the differences? Which one is better for you business?
Business Line of Credit
When you think of a line of credit, you should almost think of a credit card instead of a traditional business loan. A line of credit is essentially a pool of money that you can pull from whenever you need it. The key here is that you don’t pay interest on the money unless you use it.
So how do these lines of credit work? The first step is getting approved. After you apply for a line of credit, if you are approved, you will get a set amount of money that you can deposit into your businesses’ checking account whenever you need the money. If you wait a couple months before dipping into your line of credit, you won’t have to make any payments on that money because you haven’t used it yet. Once you withdraw money from the credit line, you make monthly payments to repay it, plus a little interest. Typically for a line of credit, the interest rate is going to be a little bit higher than a traditional business loan. One of the major differences between a line of credit and a generic business loan is that once you pay back the amount of money you took out, you can dip into it over and over again.
Another major difference is that a line of credit is not tied to a specific business operation. For example, if you get a loan for some new equipment, you can only use that loan for that specific purpose. If you get a line of credit, you can use it for almost anything business related. Lines of credit are more flexible and, once approved, more accessible than traditional business loans. The only drawback is that the interest rate is typically a little higher.
Small Business Administration Loans
In contrast, the U.S. Small Business Administration establishes guidelines for SBA loans and makes them available to businesses that cannot secure comparable financing. Unlike a line of credit, SBA loans come with partial guarantees to the lender from the U.S. Small Business Administration in the event that the borrower cannot repay the loan.
Small business loans can be used for a wide array of different purposes. They can be used for startup funds, construction loans, and even equipment loans. However, they always have a specific funding goal. However, they are not reusable and revolving like lines of credit are. Alternatively, they serve as a one-time source of capital to meet a certain company objective.
Like we mentioned before, a business line of credit should be treated similarly to a credit card. It can be used whenever needed for operational expenses, and can be paid back as soon as possible.
Small business loans are one-time influxes of capital to fund a specific business growth objective that you pay back over a long period of time.
Many companies utilize both forms of financing for their businesses, depending on the project at hand. Having a healthy line of credit available for sudden expenses or emergencies is a smart way to make sure your company has a “plan b” if needed. Using a small business loan for a specific expansion plan can be smarter than using a line of credit to save some money on the interest expense.