Line of Credit vs Term Loan

A business line of credit and a term loan are both ways to borrow money, but they work very differently. Understanding when to use each one can save you significant money in interest and give you the right financial flexibility.

A line of credit works like a credit card. You're approved for a maximum amount (say, $50,000), and you can draw from it whenever you need. You only pay interest on what you've borrowed, not the full limit. As you repay, the credit becomes available again. It's revolving — you can borrow, repay, and borrow again without reapplying. Lines of credit are ideal for managing cash flow gaps, handling unexpected expenses, and covering short-term needs like payroll during a slow month or buying extra inventory before a busy season.

A term loan gives you a lump sum upfront — say, $100,000 — and you repay it in fixed monthly installments over a set period (the "term"), typically 1-10 years for small business loans. The interest rate is usually fixed, so your payments are predictable. Term loans are better for specific, planned investments: buying equipment, renovating a space, acquiring another business, or any situation where you know exactly how much you need and have a clear repayment timeline. Once repaid, the loan is done — there's no revolving access.

Using the wrong type of financing costs you money. If you take a term loan for a short-term need (like bridging a two-month cash flow gap), you'll pay interest on the full amount for years when you only needed the money briefly. If you rely on a line of credit for a major equipment purchase, you'll likely face higher interest rates and shorter repayment terms than a dedicated term loan would offer. Many small businesses benefit from having both: a line of credit for flexibility and short-term needs, and term loans for specific investments.