The success of any entrepreneurship rests heavily on timely funds. Prospective business owners and aspiring entrepreneurs need to invest considerable capital for starting a new enterprise. Even during your entrepreneurial journey, you will face multiple situations that will require you to infuse additional funds into your business for its smooth running.
Financial assistance for businesses comes in various ways; Business Loans and Line of Credit are the most common. Though they both are credits given for business entities, there is a thin line of difference in their working. As a business owner, you must know the clear differences to utilise these popular forms of credit to the best.
What is a business loan?
A business loan is a type of term loan where you are given a specific sum of money for your business needs. You then repay this loan amount in monthly EMIs, along with the agreed interest, through the entire loan tenure.
Here, the entire loan amount is credited to your account in one go. You have to repay the set EMI every month, whether you utilise the entire loan amount or not. Also, business loans are a non-revolving type of credit. You cannot reuse the loan amount as and when you repay it.
Business loans are simple in their operation. You get the money when you need, and you repay it along with interest. That’s it!
What is a line of credit?
Contrary to business loans, lines of credit are revolving credit. They are similar to credit cards in their operation. You are given a set credit limit, and you do not have to use the entire amount in one go. You can use how much ever credit you want and repay it the next month, along with interest. You pay interest only for the amount you have utilised. The credit limit is replenished when you make a repayment and is available for you use again.
What are the differences between Business Loans and Line of Credit?
There are some fundamental differences between these two types of finances. You need to go through the differences carefully and choose the right credit facility that suits your business needs the best.
- Loan Amount: Business loans offer you a higher amount compared to lines of credit. Since business loans are given for specific purposes, like buying machinery, investing in infrastructure, capital loans, etc., the loan amount is usually higher than a line of credit. Lines of credit are primarily given to take care of minor expenses like day-to-day business expenses, paying utility bills, paying for services, etc. Hence they are issued for lower loan amounts than business loans.
- Repayment Tenure: The repayment tenure of business loans is pre-fixed and requires you to make monthly EMI payments towards your loan. But in the case of a credit line, you repay only the amount you have utilised. In that too, you can choose to repay the entire borrowed amount or just the minimum required payment. This allows for greater repayment flexibility. But remember that if you decide to make only the minimum required payment, the remaining credit amount will keep accruing interest.
- Interest rate and other charges: Line of credit usually comes with a lower interest rate than business loans. However, a line of credit can lead to higher charges if you do not use it prudently. For example, if you don’t repay the entire credit amount and just keep paying the minimum required amount, you may accrue a significant amount on the interest. In the case of business loans, there is a disciplined repayment every month in the form of EMIs. There is less chance of defaulting or getting other charges like late payment fees.
- End-usage: Business loans are tied to specific end-use, while credit lines need not be earmarked for a specific end-use. This allows greater flexibility to use the funds for your business effectively. For example, business loans may be availed specifically for capital infusion, machinery procurement, purchase of assets for the business, etc. In case of a line of credit, you do not have to specify the end-use categorically.
- Collateral or Guarantee: Business Loans are usually secured loans requiring you to present solid collateral and security for the loan amount. You need to pledge some collateral to match your loan amount. Many business loans also require a guarantor’s endorsement on the loan. However, lines of credit are not always secured loans. Many credit lines are issued based on the business history and the relationship of the business owner with the bank. This proves beneficial for business owners who have been loyal customers of the bank or NBFC for a long time.
Differences between Business Loans and a Line of Credit: At a Glance
|Business Loan||Line of Credit|
|Not Revolving Credit – The Loan amount is granted only once. To receive more, you need to apply for a fresh business loan.||Revolving Credit – You’re granted a specific amount which you can use whenever you need.|
|Repayment is in the form of fixed monthly EMIs for the entire loan tenure.||Repayment is more flexible. You can repay the entire borrowed amount or just pay the minimum due.|
|Interest is charged on the entire loan amount.||Interest is charged only on the amount you use and not on the entire sanctioned limit.|
|Ideal for large expenses like investing in real estate, infrastructure, etc.||Ideal for day-to-day expenses like inventory, paying suppliers, staff salaries, etc.|
|Generally require collateral.||Offered based on the borrower’s existing relationship with the lender.|
How to choose between a Business Loan and a Line of Credit?
Both these loan products come in handy for business owners who require continuous capital infusion for their enterprise. The deciding factor must be the interest rates and the loan amount at disposal. One should also heed to the collateral or security requirements for these finance options while keeping in mind the end use of the funds.
While business loans give you adequate sums of money for your capital investment, procuring assets and setting up a new business unit from scratch, lines of credit are more feasible for expenses like daily cash, small repairs and renovations, paying for utilities, etc.
Also, the credit line gives you much more flexibility when it comes to repayment than business loans. While this allows you to direct funds for more urgent needs, stagnating your repayments may result in higher interest accrual and ultimately a huge repayment liability.
While Business Loans are feasible during the setting up of your business, a line of credit comes in handy to take care of your business’s day-to-day needs. However, both the credit arrangements require disciplined repayment and debt management to ensure that they don’t increase your overall liability and debt burdens.