Line of Credit vs. Term Loan: Which Fits Your Business?

When a small business needs outside capital, two structures come up most often: a term loan and a revolving line of credit. On the surface they both put money in your account, but the mechanics — how you draw funds, how interest accrues, and how you repay — are completely different. Getting this choice wrong can mean paying interest on money you're not using, or running out of runway right when you need flexibility most.

How a term loan works

A term loan delivers a lump sum upfront. You agree to a fixed principal, a set interest rate (fixed or variable), and an amortization schedule — typically monthly payments of principal plus interest over 12 to 60 months. From day one you owe interest on the entire amount, regardless of whether you've deployed the capital yet. This structure is well-suited to one-time, defined purchases: buying equipment, renovating a location, acquiring another business. The cost is predictable, and the loan is self-liquidating — it disappears once the term is up.

How a revolving line of credit works

A line of credit is a credit facility with a maximum limit. You draw only what you need, when you need it. Interest accrues only on the outstanding balance — if you have a $100,000 line and have drawn $20,000, you pay interest on $20,000, not $100,000. As you repay, availability is restored, and you can draw again. This revolving nature makes a line of credit far better suited to irregular, recurring, or unpredictable needs: bridging a slow month, covering payroll while waiting on a large invoice, or seizing a short-window supplier deal.

The core trade-off: predictability vs. flexibility

Term loans offer predictability. You know exactly what you owe each month and for how long. This makes budgeting easier and is ideal when the use of funds is defined and long-lived. Lines of credit offer flexibility. You are not committed to drawing down the full limit, and your cost scales with actual usage. This is better when your needs are uneven, seasonal, or event-driven.

• —Term loan: best for one-time, capital-intensive projects (equipment, real estate, acquisition) where you need a specific sum and a defined repayment timeline.
• —Line of credit: best for working capital, bridging cash-flow gaps, managing seasonality, or having a backstop for unexpected expenses.
• —Term loan: monthly payments are fixed and easy to plan around, but you pay interest from day one on the full amount.
• —Line of credit: interest cost varies with your actual usage — potentially much lower if you only draw periodically.
• —Term loan: once repaid, the facility is closed. A new loan requires a new application.
• —Line of credit: once repaid, your availability restores automatically. No reapplication needed.

When you might use both

Many growing businesses maintain both simultaneously. A term loan funds a specific capital project — say, a second location — while a line of credit handles day-to-day working capital needs. The term loan's fixed payments are easy to model in a budget. The line acts as an always-available liquidity buffer. This combination is common among businesses with $500K+ in annual revenue and at least two years of operating history.

Key questions to ask yourself

• —Do I need a specific sum for a defined purpose, or ongoing access to flexible capital?
• —Is my cash need one-time or recurring?
• —Can I accurately predict how much I'll need, or will that number change month to month?
• —Do I want predictable, fixed monthly payments, or am I comfortable with a variable balance?
• —How long will it take for this capital to generate a return — and does that timeline align with a term loan's repayment schedule?

Indicative only — not a commitment to lend. Actual rates, terms, and eligibility depend on your business profile and the lender's current credit policies.