Both are methods of borrowing money, but they are not similar in many ways. If you are an entrepreneur who plans to borrow money for your business, it will be a smart move to understand first the advantages and disadvantages of each method before you make your decision.
To give you a much clearer idea, standard loans, such as personal loans and mortgages, are typically released (one-time) to the borrower in a lump sum and the repayments are made on an iinstallment basis. Once an installment loan has been paid off, consumers won't be able to spend the funds again as they need to apply for a new loan.
Lines of credit, on the other hand, are similar to how credit cards work in which a borrowing limit is granted to a consumer. The consumer has the choice whether to maximize the credit limit or just use a part of it, and of course, the interest will be applied only to the amount used.
For example, you are given a borrowing limit of $5000, but let's say you only need $2000 at the moment. Once you withdraw $2000 from your credit line, the interest rate you'll have to pay will only be calculated against $2000, not $5000. Once you pay back the $2000 you borrowed, your credit line will again return to $5000.
Now, which method do you think is better for your business? The best way to figure it out is to estimate first what your business really needs, then compare the two methods to fully understand each one's pros and cons, then also compare the terms that various lenders are prepared to offer you.
Do you need quick cash or capital? If yes, the fastest way for you to receive funding is through lines of credit. They offer an easier application process and the chances of approval is higher compared to standard loans. Meanwhile, if you have a business plan in mind that requires more funds, getting a loan is the better choice for you.
To give you a more specific comparison of these two business financing options, let's start with what lenders usually require to approve a borrower's application for standard loans and lines of credit.
More often than not, banks and other lenders require loan applicants to provide a specific purpose on how they will use the loan they are applying for. This will be a part of their evaluation on whether they will grant their approval or not.
When it comes to lines of credit, applicants are not required to provide a detailed purpose for their application. Once granted, borrowers can just use their credit line to purchase whatever they want as long as they don't exceed their limit.
In terms of interest rates, given that the loan amount is of the same or comparable value, lines of credit may cost lower or higher as compared to standard loans because their rates vary. As for payment terms, let me quote Adam Hayes of Investopedia: "While credit cards always have minimum monthly payments based on a percentage of current credit balances, lines of credit do not necessarily include monthly payment requirements."
In a nutshell, here are some specific points that entrepreneurs must remember when choosing which of the two finance options, standard loans or lines of credit, is better for their business:
For large and long-term financing needs, getting a standard business loan is more appropriate since you get the full amount once approved and they can be paid in fixed and longer repayment terms that match your financial capability. For small, short-term business needs though, getting a credit line for your business is a wiser choice since it offers flexibility not only in terms of how much you can withdraw or spend out of your borrowing limit, but also how you are going to use it.
Both financing options can be beneficial for your business, but at the end of the day, whether you choose to get a standard loan or a credit line, remember what matters in the end is how wise you are in managing your funds and handling your debts. Be a responsible borrower.
