Credit lines versus business loans… how to know which option works best for you

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Credit lines versus business loans… how to know which option works best for you

Published By Janet Gershen-Siegel at August 16, 2017

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Credit lines? Business loans? It can surely get confusing when you’re looking to finance your business.

Both financing methods are used to help with cash flow problems. Both can help you take advantage of opportunities to purchase less expensive equipment or land, keep inventory in stock, or even to make payroll. For businesses, particularly new ones and seasonal ones, cash flow can be unpredictable at best. Both financing methods can help you to eliminate uncertainty and keep your business going. So you’re probably wondering: what are the advantages and disadvantages of each?

Let’s start with some definitions.

Credit Lines

A credit line, or business line of credit, is generally an agreement between a financial institution such as a bank, credit union, or online lender; and a customer. In this instance, the customer is not an individual. Rather, your business is the customer. Furthermore, the credit line establishes a certain maximum loan balance which the lender will allow the borrower to maintain. Hence, the borrower can borrow on whatever the maximum amount is, so long as they do not go over it.

According to Kabbage.com (an online lender providing business lines of credit to small businesses), generally a lender will prefer to see your line of credit hit a zero balance at some point. That is, they want you to have the line of credit completely paid off during any given year. Hence you don’t want to borrow more than you can pay back during a relatively short window of time. In addition, a business line of credit generally ranges from around $10,000 to $500,000, depending upon your individual business’s needs.

The Advantages of Business Lines of Credit

Probably the biggest advantage is that there is no interest charged on any part of the credit limit which is unused. Plus the business can draw from the line of credit at any time, giving this method a measure of convenience. In addition, a business line of credit, while it works a lot like a credit card, does not come with a credit card’s hefty fees.

The Disadvantages of Business Lines of Credit

The biggest issue with a business line of credit is that it can be classified as a demand loan. This means that the business must pay back the amount borrowed as soon as possible once requested by the lending institution.

Business Loans

At its simplest, a business loan (just like a personal loan) is an amount of capital borrowed which must be repaid in accordance with the loan’s specific terms and conditions.

The Advantages of Business Loans

There are a few interest options to choose from. These include fixed-rate interest, where the loan’s interest rate stays the same throughout the loan’s duration and its payback period; and variable-rate interest, where the interest rate can change depending on certain factors as defined by the lender. Payback periods can also vary, as can the amount and type of collateral necessary to secure the loan.

A business owner who is also a homeowner can, according to Kyra Sheahan at the Houston Chronicle, potentially use home equity as a means of securing a business loan. Collateral can also, per Rebecca Lake of the Houston Chronicle, be used to get a more favorable interest rate from the lender.

In addition, business loans are more likely to be approved for higher amounts than business lines of credit. And the Small Business Administration can even provide a guarantee to lenders for the funds they lend to small businesses (the SBA does not actually lend money to small businesses).

The Disadvantages of Business Loans

First of all, there are no guarantees that your business will even get a business loan. Lenders evaluaterisk all the time, and if the lender feels your business cannot pay back the loan, then they will not approve the loan.

Second, because you might need to provide a personal guarantee, your personal assets could be on the line if it turns out you cannot repay the loan.

Finally, if you default on a business loan, the lender has the right to come after you in civil court and seek a judgment. And the only way you will be able to erase that judgment will be to either repay the loan or get it discharged in bankruptcy.

Which is best?

Weighing the two financing methods, a few things are clear. If your business needs cash now and will need it quickly, but can also pay it back quickly, a credit line is probably going to better fulfill your needs. But for longer-term and larger borrowings, a business loan seems like a better option. And with both types of financing, always be sure to watch the interest rates and read the fine print.

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