Key takeaways
- A business loan provides one-time funding to help start or grow a business
- Lines of credit cover short-term financing needs and let businesses borrow funds repeatedly
- Banks, online lenders and CDFIs may offer term loans and lines of credit
A business loan offers funding that small businesses need to make strategic purchases to boost growth. Small businesses can choose from many types of business loans, including term loans and lines of credit.
According to the Federal Reserve’s 2024 Report on Employer Firms, business lines of credit and business loans are the top financing sources that employer-based businesses apply for. Forty-three percent applied for business lines of credit, while another 36 percent went with a business loan.
Of those applications, 73 percent were approved for a line of credit, while 65 percent were approved for a business loan.
There may be overlap in how you can use the funds from either loan. The loan amount you need, interest rate and ability to reuse credit can help you choose the best option for you. Let’s dive into the features of business loans versus lines of credit.
What is a business loan?
A business loan is a contract between a business and a lender offering funds to the business that it will have to repay. The business can use the borrowed money to grow its operations, buy property or expand into new products and services. The purpose of the loan is to boost the business’s growth more quickly than if it waited for higher profits to expand.
How does a business loan work?
When getting a business loan, a business receives money to use for business expenses or new purchases with the expectation that it will repay the loan.
The lender then charges interest and fees to offset the risk and the costs of lending money. The interest charged can be fixed or variable. With a fixed-rate loan, the interest rates won’t change over the life of the loan, but they can change with a variable-rate loan.
Most business loans also set a fixed amount of time that the loan must be repaid in, called the repayment term. Repayment terms are typically anywhere from six months to ten years, depending on the lender and your business’s eligibility.
Bankrate insight
The best business lenders offer attractive features for their business loans, including high loan amounts, long repayment terms and low starting interest rates.
What is a business line of credit?
A business line of credit offers businesses a set loan amount that they can borrow at any time up to the limit determined by the lender. Businesses can borrow any amount at or under the credit limit. Lines of credit also typically let businesses borrow money repeatedly. It’s ideal for covering last-minute or ongoing expenses, such as managing dips in cash flow.
How does a business line of credit work?
Once your business draws from a line of credit, the repayment term starts and interest is calculated on the amount you borrow. You typically repay the loan on a weekly or monthly basis. Repayment terms can last between six and 24 months for short-term lines of credit or five years or longer for long-term lines of credit.
When you draw funds, your available credit is lowered by the amount borrowed. But it replenishes as your business makes payments, allowing you to draw new funds at any time. In addition to the interest that you’ll have to pay, some lenders charge a draw fee each time you borrow money.
Bankrate insight
The best business lines of credit offer high credit limits, long repayment terms and quick approvals. In many cases, business lines of credit offer more lenient eligibility requirements than business loans, such as accepting a 600 personal credit score.
Compare business loans vs. business lines of credit
A business loan provides funds for a business in one lump sum. Once you’re approved, you start making payments with interest charged right away. While you can use the funds for nearly any purpose, you typically need to state the purpose on the loan agreement when you apply for funding. Business term loans tend to offer higher loan amounts and longer repayment terms than business lines of credit.
But a business line of credit lets you draw funds whenever you need them, only paying interest on the amount you draw. You don’t need to state the purpose that you’re using the funding for when you withdraw. Business lines of credit may come with a lower credit limit than a business loan, such as capping at $250,000. Many lines of credit accept startups or businesses with bad credit, while you may need strong credit or an alternative lender to get approved for a business loan.
Let’s look at the differences between getting a business loan versus a line of credit.
| Business term loan | Business line of credit | |
|---|---|---|
| Typical interest rates | 6% to 45% | 8% to 60% |
| How interest is charged | On the entire loan | Only on the amount used |
| Typical repayment terms | 2 to 10 years | Online lenders: 6 to 24 months Banks: 2+ years |
| Repayment schedule | Typically monthly | Weekly or monthly, starting when you withdraw funds |
| How to get new funding | Must apply for new loan | Can draw from available credit at any time |
When to consider a business loan
A business loan may work best if you:
- Need a loan for a specific purchase
- Need high loan amounts, such as $500,000 or more
- Want set repayment terms with a defined end date
- Don’t need to use the credit for future purchases
When to consider a business line of credit
A business line of credit may be best if you:
- Want access to credit as needed
- Want to use the line for future purchases
- Need to make small purchases or cover cash flow gaps
- Want to only pay interest on the amount you withdraw
- Can’t qualify for a conventional business loan through your preferred bank
Where to get business loans or lines of credit
You can get business loans and lines of credit from traditional banks, online lenders and community-based lenders — with each lender offering different benefits. For example, traditional banks offer in-person service and low interest rates, while online lenders often have more lenient eligibility requirements than traditional lenders.
Here are examples of different types of lenders where you can get business loans or lines of credit:
Banks
Traditional banks tend to offer low interest rates for a variety of loans, including term loans and lines of credit. They may offer multiple line of credit options, including secured lines for credit-building.
But banks often have strict lending criteria for all of their loan products, such as a credit score of 670 or higher and annual revenue of around $200,000. They may lower requirements for a line of credit compared to a term loan, but the criteria may still be higher than other lenders.
Let’s look at the features of term loans and lines of credit for different banks.
Online lenders
Getting approved with online lenders tends to take less time and requires less in terms of revenue and credit score. They’re typically a better fit for startups and business owners with poor credit. But online lenders may stick with short-term loans, and you can expect higher interest rates than traditional banks. Here are examples of what online lenders offer:
Community development financial institutions (CDFIs)
Community development financial institutions (CDFIs) are community-based lenders designed to boost the business outlook of underserved communities. They may accept small businesses with credentials that don’t fit traditional lenders’ standards, such as low revenue or poor credit history. Let’s compare what loan features look like for these lenders.
Bankrate insight
According to the Federal Reserve’s 2024 Report on Employer Firms, the main factors that influenced where a business owner applied are:
- Existing relationship with a lender
- Funding speed
- Their expectations for getting approved
Alternatives to business loans and lines of credit
A traditional business loan may not serve your purpose for financing or be available to you because of your credit history. In these cases, you can try a host of alternatives, such as:
- Business grants: Business grants offer business funding without having to repay the money. But they’re not a surefire way of getting funding. You may need to show why your business deserves the grant and compete with other businesses to receive the award.
Bankrate insight
To boost your chances of getting a grant, try applying for business grants that fit your industry or help underserved communities if you qualify. You can find grants specialized for:
- Business credit cards: Business credit cards are revolving credit, giving you access to funds that you can reuse as you pay back past loans. You also receive points and rewards for your purchases But you typically need strong credit to qualify, unless you go with a credit card geared for subprime credit like the Spark 1% Classic or a secured credit card.
- Crowdfunding: Crowdfunding gives you a chance to raise funds for your business either through simple fundraising or by seeking out investors. You can get started by searching for crowdfunding platforms, such as Kiva or Kickstarter. When using investors, you usually either offer rewards or sell shares of your company, which is known as equity crowdfunding.
- Peer-to-peer lending: Peer-to-peer lending can help your business get a loan funded through individuals rather than a financial institution. You may raise funding through individual investors that you then need to repay over a set time with interest. This type of financing lets you get a loan while bypassing credit and revenue requirements.
- Invoice factoring: Invoice factoring works by selling outstanding invoices to a factoring company that collects the payments. Your business gets an advance of up to 90 percent of the invoice amount that you can use for any expenses. Once the factoring company receives payment, it takes out fees and pays your business the remainder.
- Merchant cash advances: Merchant cash advances forward capital to your business, using your past credit or debit sales as a basis for approval. You don’t need strong credit to qualify, but repayments are usually aggressive, requiring you to pay daily or weekly from a percentage of your sales.
Bottom line
Many business owners go with a business loan or line of credit to access the funding they need. While there are similarities, most businesses use term loans for one-time funding and repay over the course of several years. Short-term loans are available with terms as short as six months.
Meanwhile, businesses get approved for a line of credit with a set borrowing limit. They can borrow from that amount at any time, which is helpful for emergencies or small expenses. To make a decision, review the loan features with different lenders and prequalify to see what rates and terms you can get.
