If you're shopping for business funding for the first time, two products will dominate the conversation: the term loan and the line of credit. They're often pitched interchangeably, but they're built for very different jobs. Choosing the wrong one is one of the more expensive mistakes a business owner can make.
Here's a clear, no-jargon breakdown of when each one fits, and the questions to ask before you sign.
What a term loan actually is
A term loan is a single lump sum of capital, repaid in fixed payments over a set period, usually anywhere from 6 months to 10 years (longer for SBA loans). Think of it as the business equivalent of a mortgage or auto loan: you borrow $250,000, you pay it back over 36 months at a fixed rate.
Term loans are best for predictable, one-time investments with a clear payback story:
- Buying out a partner or acquiring a competitor
- Build-out of a new location
- A major equipment purchase
- Refinancing higher-cost debt into a single, lower payment
The trade-off: you start paying interest on day one, on the full amount, whether you've deployed the capital yet or not.
What a line of credit actually is
A line of credit is a pre-approved pool of capital you can draw on as needed. If you're approved for a $500,000 line and you only use $80,000, you only pay interest on the $80,000. Pay it back, and the full line is available again.
Lines of credit are best for unpredictable, recurring, or short-term needs:
- Smoothing out cash flow in a seasonal business
- Bridging the gap between paying suppliers and getting paid by customers
- Inventory buys ahead of a busy season
- Having "dry powder" ready for an opportunity that hasn't shown up yet
The trade-off: rates are usually variable (they move with the market), and most lines come with an annual renewal, meaning the bank can adjust your limit or pull it.
The fast decision framework
When clients ask us "which one?", we walk them through three questions:
1. Do you know exactly how much you need, and exactly what you're using it for?
If yes, you're in term loan territory. A term loan rewards you for having a plan. The fixed schedule and lower (usually) rate beat a line of credit when you're going to deploy the full amount immediately.
2. Is the need recurring, seasonal, or hard to predict?
Then you want a line of credit. Paying interest on capital you haven't used yet is one of the most common, and avoidable, ways businesses overpay for funding.
3. How fast do you need to be ready to move?
Lines of credit are incredibly valuable when you need optionality. A pre-approved line means you can move on a deal (buying inventory at a discount, snapping up a foreclosed lease, hiring opportunistically) the day the opportunity appears, not three weeks later when financing closes.
What to ask before you sign
Whichever product you choose, do not sign anything before you can answer these in writing:
- What is the all-in APR? Not just the "rate." The APR includes origination fees, draw fees, and any other charges, which is the only way to compare offers fairly.
- Are there prepayment terms? Some products allow early payoff with savings, others have a fixed total payback. Both have their place. Just make sure you know which one you're signing.
- Is the rate fixed or variable? If variable, what's the index, and what's the cap? This matters more in environments where rates move.
- What are the renewal terms? (Lines of credit only.) Can the lender reduce or pull the line? Under what conditions?
- What's the personal guarantee requirement? Almost all small business funding requires one. Make sure you understand exactly what you're signing.
Any reputable lender, including us, will answer all five of these in plain English, in writing, before you sign.
Not sure which is right for your business?
Apply once, and a real human will recommend the product that actually fits.
The bottom line
Term loans are for plans. Lines of credit are for flexibility. The right choice almost always depends on your specific situation, and a good funding advisor will steer you toward the product that fits your business.
If you're weighing options, we're happy to take a look. Apply in five minutes, and we'll come back with a recommendation that fits your situation.