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Small Business Loan vs. Line of Credit

Published Oct. 22, 2024
Brittney Myers
Author: Brittney Myers
Brittney Myers
Brittney Myers
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Brittney started her writing career in the world of science, putting her physics degree to good use. Her journey into finance started with building her personal credit, but soon grew into a borderline obsession with credit cards and travel rewards. For the last 7 years, she has enjoyed the ability to share her expertise with readers, as well as the opportunity to interview companies and individuals making an impact on our financial lives. She wholly believe most problems can be solved with the right research -- and a good spreadsheet -- and she specializes in translating complex financial topics into actionable advice to help educate and empower readers.

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Eric McWhinnie
Fact Checked: Eric McWhinnie
Eric McWhinnie
Eric McWhinnie

Eric McWhinnie has been writing and editing digital content since 2010. He specializes in personal finance and investing. He also holds a bachelor’s degree in Finance.

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In a perfect world, our businesses would be self-funded and profitable right away. In reality, data shows about two-thirds of small business owners have used outside funding in the last five years. Most use it to meet operating expenses, though about 20% use the funding to expand their business.

No matter what your business's financial need, chances are good you'll be looking at either a small business loan or a small business line of credit. Each type of business funding has its own pros and cons, which we'll break down so you can decide the best option for your business.

What is a small business loan?

A small business loan is an installment loan used to finance business expenses or purchases. Business loans are term loans paid out in a lump sum, then repaid -- with interest -- through regular installments.

Short-term business loans tend to have repayment terms of six to 24 months. Longer loans can have repayment terms of 10 years or more.

Pros of a small business loan

  • Paid out as a lump sum
  • Set interest rate won't change
  • Consistent repayment amount

Cons of a small business loan

  • Often requires collateral
  • One-time use (contract ends when total repaid)
  • Use may be restricted by loan type

What is a small business line of credit?

A business line of credit is a revolving credit account that works sort of like a business credit card (but without the rewards). You get a set maximum credit limit, and you can borrow up to that limit.

You can repay your balance and borrow again, then repeat as needed (some credit lines may have a set draw period, terms vary). You only pay interest fees on the amount of credit you use.

Pros of a small business line of credit

  • Can be repaid and reused over and over
  • Few restrictions on use
  • May not require collateral

Cons of a small business line of credit

  • Monthly payments vary
  • Interest rate may vary
  • Requires personal guarantee

Major differences between an SMB loan and line of credit

Here's a breakdown of the key ways business loans and business lines of credit vary.

Small Business Loan Small Business Line of Credit
One-time funding: The contract ends when you pay off the balance. Reusable funding: You can borrow money, pay it off, then borrow again, etc., up to your credit limit.
Set monthly payments: Your monthly payments will be the same throughout the loan period. Minimum monthly payment: Your monthly payments will depend on how much of the credit line you're using at the time.
Set interest rate: Most loans will have a set interest rate that is locked in for the life of the loan. Variable interest rate: Lines of credit can have variable interest rates that change with the market.
Secured loans: Many business loans, especially larger loans, will require collateral. Personal guarantee: You'll usually be personally liable for the balance of a business line of credit.
Use may be restricted: Some types of business loans are designed for specific purposes only. Can be used for anything: Few credit lines will have restrictions on what you can use the funding for (minus illegalities, etc.).
Tends to have higher max: Business loans can get into the seven figures for qualified businesses. Typically lower amounts: Business credit lines are generally smaller than loans (this varies a lot by revenue and qualifications).

Which is cheaper?

Neither funding method is necessarily cheaper than the other. The total cost of your loan or credit line will depend on a lot of variables, including:

  • The interest rate: Higher interest rates will result in more interest fees.
  • The lender fees: Some lenders may charge extra fees, such as an origination or administrative fee to open your loan, or an access, account, or draw fee for using a line of credit.
  • The terms: The longer you take to repay what you borrow, the more it will cost in interest fees (assuming similar APRs).

Generally, installment loans tend to have lower interest rates than lines of credit, but can come with more fees. It's a good idea to compare the overall costs from multiple lenders to get the best deal.

Which is easier to get?

Which type of business funding is easier to get will depend on your qualifications. If your business has strong collateral, then a business loan could be easier to get. If you have no collateral but excellent personal credit, then a business line of credit may be the easier option.

How to choose which is right for your business

Both types of funding can be useful in the right circumstances. The trick is knowing when to use which type. Here are a few questions to ask yourself to help choose between a business loan vs. line of credit.

Do you have collateral?

The majority of business loans of any appreciable size will be secured loans, meaning they require some sort of collateral. What type, and how much, collateral you need to put forward will depend on the type and amount of the loan.

For example, equipment loans may use the goods you're purchasing as collateral for the loan. In other cases, you may need to agree to a blanket lien, which gives the lender the ability to claim your business's assets if you don't pay your loan balance.

The larger the loan you need, the more likely the lender is to require adequate collateral to back it up. Without collateral, a line of credit may be the better option.

Is your personal credit good?

Having good personal credit will help you get financing of pretty much any type, personal or business. But it's especially important for unsecured financing (financing without collateral) such as a line of credit.

If you don't have the collateral necessary for a business loan, but you have excellent personal credit, you could get approved for a line of credit so long as you agree to a personal guarantee.

How much money do you want to borrow?

Well-qualified business owners can find some pretty hefty credit lines (up to $500,000 from some major banks). However, if you need to borrow more than your bank offers via a credit line, then a business loan may be the better option.

Even if your bank offers credit lines large enough for your needs, your business may not qualify. If you have the collateral to back it up, a six-figure business loan could be easier to get than a similar-sized credit line.

Will you need funding again soon?

Arguably the most substantive difference between a business loan and a line of credit is that a loan is a one-time finance deal, while a line of credit can be used over and over again.

If you have a regular need for financing, such as to cope with seasonal changes in revenue, then a line of credit could be much more useful in the long run. If you simply need a one-off influx of cash, then a business loan could be plenty.

What is it going to cost?

In the end, if all other factors are equal, then the decision will probably come down to cost. Make sure to consider the interest fees, as well as any origination, account, or administrative fees that may add to the cost of the loan or credit line.