Businesses often need a source of money to fund expansions, for additional working capital during slow seasons, and other reasons. The two most popular options for obtaining the funding they need are business loans and business lines of credit.
In the battle of business loan vs. line of credit, which option is the winner? The outcome depends on what you need the money for, and both financing options have important pros and cons to consider.
A business loan is financing that is used to either start a new business or grow an existing business. Kimber Kable, for example, is a company that uses Wasatch Peaks Credit Union for its business financing needs. It makes high-quality audio and video cables and ships them all around the world. We have been privileged to have them as members.
What Is a Business Loan?
Business loans are issued by banks, credit unions, and private lenders. A few things that business loans can be used for include:
- Real estate
- Working capital
- Expanding operations
How much you can borrow with a business loan depends on several factors including the purpose of the loan, business type, age of the business, and other things. A business loan could be for a small amount – just a few thousand dollars – but it could also be for millions of dollars.
Although business loans can be used for many different purposes, lenders do require borrowers to state the specific reason for the loan when applying. Both secured and unsecured business loans are available, and interest rates can be either fixed or variable. Repayment terms vary depending on the amount of the loan but can be as long as 25 years.
How Do You Qualify for a Business Loan?
The process to apply for a business loan is not complicated, and many lenders give you the option to apply either in-person or online. The documents you will need to fill out the application will vary depending on the lender but may include:
- Bank statements
- Financial statements
- Business plan
- Business tax ID number
- Business tax returns
Lenders want to make sure that a business is positioned for long-term success before a loan is approved to make sure the money can be repaid. Factors that will be reviewed may include:
- Credit score
- Cash flow and income
- Age of the business
- Type of business
Business Loan Pros and Cons
Business loans have several things going for them to consider. First, their interest rates may be lower than other funding options, such as credit cards. The interest on these loans may also be tax-deductible. If a business is relatively new, making on-time payments on a small loan could allow the business to build credit so that it could qualify for larger loans in the future.
An important negative of business loans is that they are more difficult to obtain for startups than for established businesses. A new startup will have to undergo a lengthy review process to make sure it is viable. Lenders do this to reduce their risk as much as possible.
Many lenders also require borrowers to provide collateral for secured loans. This is another way that lenders reduce their risk. If the business isn’t profitable and the owner is unable to repay the debt, the lender will take possession of the collateral and then sell it to recoup the money.
Business Line of Credit
A business line of credit is a highly flexible loan that operates differently from a business loan. Although the purpose of the loan and the application process are similar, there are significant distinctions between the two.
What Is a Business Line of Credit?
While business loans are often obtained for specific purposes, such as buying new equipment or inventory, a business line of credit is more flexible and can be used for many different purposes.
Business lines of credit operate similar to credit cards and are offered by both banks and credit unions. With a line of credit, money is withdrawn as needed. The borrower can then make interest-only payments for as long as the loan is active.
The amount of available credit can be replenished by repaying the principal. If a borrower opts for interest-only payments, however, a balloon payment for the principal will be due when the loan is closed.
A business line of credit can be either secured or unsecured. If it’s secured, the borrower must have collateral to obtain the loan. Unsecured loans will be more difficult to obtain.
The requirements to qualify for this type of business loan will vary depending on the lending institution but are similar to business loans. Applicants will need strong credit scores and financial statements. It is also preferable that the business be at least two years old.
Business Line of Credit Pros and Cons
There are several important benefits of business lines of credit. They are highly flexible and can be used for many different purposes. You can also withdraw only the amount you need instead of receiving a lump-sum payment. This makes them useful for balancing cash flow during slow seasons to help out with payroll and other expenses.
An important negative of business lines of credit is that they have variable interest rates. This could make this type of funding more expensive than a business loan if the interest rate goes up. Depending on the lender, you may also have additional fees to pay.
Business lines of credit also typically have much lower borrowing limits. Because of this, they are not good options for large expenses like property, plant, and equipment.
Business Loan vs. Line of Credit? Let Wasatch Peaks Help You Choose!
Whether you opt for a business loan or a business line of credit depends on your needs. If you need a large loan to purchase new equipment, inventory, or to expand your operations, a business loan would be best. If you need a smaller loan that you can periodically access, however, a line of credit might make more sense.
Wasatch Peaks Credit Union offers both lines of credit and SBA-backed business loans. Regardless of your goals or needs, we have funding solutions that can help you start a new business or expand an existing venture.