Business line of credit vs term loan: which one do you need?
Reviewed by Turan Zeynal, Managing Partner, Outset Funding Partners ·
A line of credit is a revolving facility — draw and repay on demand, interest only on what you use. A term loan is a one-time lump sum with fixed monthly payments. Use a LOC for cash-flow smoothing, seasonal gaps, and short-term inventory. Use a term loan for one-time capital projects with a defined payback horizon.
Quick facts
- LOC cost
- 8% – 25% APR
- Term loan cost
- 8% – 30% APR
- LOC speed
- 1 – 3 weeks
- Term loan speed
- 1 – 4 weeks
- LOC structure
- Revolving
- Term loan structure
- Installment
- LOC min credit
- 650+
- Term loan min credit
- 660+
The 60-second answer
The confusion here is legitimate — pricing and qualification look almost identical on paper. The difference is structural. A LOC is like a credit card without the card: you have a limit, you draw what you need, you repay, and the credit becomes available again. A term loan hands you the full amount up front and locks in a repayment schedule.
The right question is: is this one purchase, or an ongoing capacity you need to have available? If you're buying a single piece of equipment or funding a defined expansion project, a term loan matches the cash flow perfectly. If you're smoothing a seasonal dip or building buffer against a slow month, a LOC is the right tool — a term loan would force you to take (and pay interest on) money you might not need.
Pros and cons
- ✓LOC only costs you interest on what you actually draw
- ✓LOC gives you standby capacity for emergencies
- ✓LOC is reusable — repay and re-borrow
- ✓Term loan gives you the full lump sum at once for one-time purchases
- ✓Term loan has predictable fixed payments for budgeting
- ×LOC requires ongoing lender review; limit can be cut
- ×LOC draw fees and maintenance fees can add up
- ×Term loan forces you to borrow (and pay interest on) the full amount even if you only need half
- ×Term loan isn't reusable — a second project means a second application
- ×Both typically require 650+ FICO and 1+ year in business
Side-by-side
| Option | When to use | Watch out for |
|---|---|---|
| Structure | LOC: revolving credit line | Term loan: installment, one-time |
| Interest | LOC: only on drawn balance | Term loan: on full principal |
| Repayment | LOC: monthly interest, principal flex | Term loan: fixed monthly P&I |
| Best use | LOC: cash-flow gaps, seasonal | Term loan: one-time expansion / asset |
| Reusable? | LOC: yes — restores as you repay | Term loan: no — single draw |
| Draw fees | LOC: sometimes 1–3% per draw | Term loan: origination 1–5% once |
| Term length | LOC: 6 mo – 5 yr, renewable | Term loan: 1 – 10 yrs |
Frequently asked questions
Is a line of credit or term loan cheaper?
It depends on how you use the money. If you'd borrow the full amount on day one and pay it back on schedule anyway, a term loan is usually slightly cheaper. If you only need part of it or only sometimes, a LOC will cost dramatically less because you're only paying interest on what you draw.
Can I have both a line of credit and a term loan at the same time?
Yes — this is the standard capital stack for a healthy small business. A term loan funds long-term assets or expansion; a LOC covers working capital and cash-flow variability.
Which is easier to qualify for?
Term loans are usually easier for first-time borrowers because underwriting is one-and-done. LOCs often require slightly stronger financials since the lender is committing to ongoing available credit.
Do lines of credit have prepayment penalties?
Rarely — you pay down whenever you want and re-borrow when you need to. Term loans sometimes have prepayment penalties on the first 1–3 years, so check the note before signing.
Which one shows up better on business credit?
Term loans establish a clear payment history quickly. LOCs report utilization — high utilization can drag your business credit down the same way maxed-out consumer credit cards do.
Sources
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