What is one difference between a term loan versus a line of credit? What are the pros and cons?
To help you understand the differences between a term loan and line of credit, we asked finance professionals and business owners this question for their best insights. From interest rates to the duration of the asset being financed, there are several differences between a term loan and a line of credit and the pros and cons of each.
Here are five differences between a term loan and a line of credit:
- Interest Rate
- Repayment Structure
- Ease of Access
- Method of Utilization
- The Duration Of The Asset Being Financed
A term loan is a loan with a fixed interest rate and a specified repayment schedule. A line of credit, on the other hand, is a revolving loan that allows you to borrow up to a certain limit and repay the debt as you please.
A term loan might be a better option if you need to borrow a large sum of money and know exactly how much you’ll need to pay back each month. A line of credit may be more suitable if you need access to funds on an as-needed basis or if you’re not sure how much money you’ll need.
Claire Westbrook, LSAT Prep Hero
Term loans have set and predictable structures when it comes to repaying them, while lines of credit are more fluid. Lines of credit do not have defined terms for repayment like term loans. With a term loan, you have to make equal payments at equal time increments, whereas with lines of credit you only have to repay what you use. Lines of credit can be useful for things like unexpected emergencies or when you need access to pay for something quickly, but you only have to pay for what you use (plus interest). Once you’ve paid back what you’ve used, your balance returns to the full amount to be used again when needed. Term loans, on the other hand, require that you start paying back the balance immediately even if you haven’t used the money yet. They have a set repayment schedule that must be followed and also have fees on top of interest.
Brett Sohns, LifeGoal Investments
Ease of Access
A term loan is a one-time funding consisting of an agreed amount from your lender. These kinds of loans are tougher to get and will require collateral. Lines of credit on the other hand are routine financing options meant to meet business expenditure. A business can decide to use the whole facility available to them at once or use it in installments up to their limit.
Term loans are efficient for long-term investing, but they can be more difficult to access due to business credit scores and other financing policies. Lines of credit exist to ensure your business never runs out of cash to use. However, they have a higher interest rate.
Ryan Yount, Luckluckgo
Method of Utilization
A term loan refers to a lump sum amount that you receive from your creditor depending on your business credit score and your personal credit score. Term loans can be short-term loans or long-term. In most instances, short-term loans are once with a repayment deadline of below twelve months; anything more than that falls into midterm to long-term loans.
A line of credit, on the other hand, is recurrent finance facilitation that allows you to meet emergency expenses in your business. This type of funding is available to use recurrently or the whole sum in one go. Most businesses will access this type of credit for month-on-month expenses rather than to address long-term developments and projects.
John Tian, Mobitrix
The Duration Of The Asset Being Financed
If you want to break down debt into its most basic form, there are 2 types of debt. Debt that goes up and down with usage/need (line of credit), and debt that stays out for a longer period of time (term loan).
Lines of credit and term loans should be matched with the duration of the asset that is being financed. Lines of credit should be looked at as short-term instruments that bridge a short-term gap between liabilities and assets. A good example of a line of credit would be to finance accounts receivable or inventory needs so that you don’t burn through valuable cash.
Term loans should be looked at as leverage to acquire a long-term asset. Term loans should typically be matched up to the useful life of the asset. For example, if a piece of equipment has a 10-year useful life, the term loan should not extend more than that 10 year period of time. Debt is an important part of any balance sheet but should be used judiciously to match the asset with the debt need.
Isaac Bunney, RevTek Capital