For small businesses, you will often have to choose between getting a loan or considering a business line of credit. But what are these two financing options and how do you choose between the two?
What Is a Loan?
When many people think of a business loan, they often think of the financing option offered by different lenders. In strict terms, a loan is a borrowing avenue that gives you access to the amount of money you need at the time. It is a one-time borrowing facility, which means you have to finish repaying one loan before you can get another from the same lender.
There is usually a monthly or annual interest rate attached to a loan depending on your credit rating, how much you need to borrow, the repayment period, as well as the relationship you have with a particular lender.
For business and personal use, you can get either a secured or unsecured loan. The main difference is that you need to provide some form of collateral or security to get a secured loan.
Unsecured loans rely on a borrower’s credit history and rating and are usually offered for smaller amounts, which makes them a less than ideal solution when you need to finance a huge investment.
Lines of Credit
A line of credit is part of what is known as revolving credit products. A line of credit is a facility that allows you to borrow over and over again up to a certain limit.
The borrower draws money from the limit set, repaying and borrowing over and over again. A good example of such a facility is a business credit card.
One of the biggest drawbacks of using a line of credit is that they tend to have a higher interest rate, but they also have smaller minimum payments than other credit facilities such as loans. The borrower is also required to make monthly payments where they pay both the interest and the principal.
Loans or Lines of Credit?
Loans are usually the perfect option for large, one-time business financing. This includes things like purchasing inventory or leasing new equipment. Lines of credit are better for smaller recurring expenses. These can include improving cash flow, paying payroll, or even renting office space.
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A loan will usually have a fixed interest rate, which means that the interest rate that was quoted to you when you borrowed the money will apply for the duration of the loan. Lines of credit, on the other hand, have variable interest rates. These interest rates can change every time you draw some money from your credit limit. You may have to make different calculations every time you want to borrow some money.
When businesses need a fresh cash injection, they often have the option of taking a loan or opening a business line of credit. Although both of these are viable financing options, they come with their own sets of pros and cons. Lines of credit seem to be a better option for small businesses as they need frequent cash injections which bigger businesses don’t tend to require.
Image Credit: financing your business by Pixabay
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