Term Loan vs Line of Credit: Which Should Your Business Choose?

Term Loan vs Line of Credit: Which Should Your Business Choose?

Term loans and lines of credit are the two most common financing products for small businesses, yet they work in fundamentally different ways. Choosing the wrong one can cost you thousands in unnecessary interest, create cash flow pressure, or leave you without access to capital when you need it most. Understanding the structural differences between these products, and when each one is the right tool, is essential for smart business financing.

This guide provides a clear, objective comparison of term loans and business lines of credit, including how each works, what they cost, when to use them, and how to decide which product fits your situation.

How a Term Loan Works

A term loan provides a lump sum of capital that you receive all at once and repay over a fixed schedule with regular payments. Once the loan is funded and repaid, it is closed. If you need additional capital, you must apply for a new loan.

Structure:

• You receive the full loan amount upfront
• Repayment occurs over a fixed term (typically 1 to 25 years depending on loan type)
• Payments are usually monthly and include both principal and interest
• The interest rate can be fixed or variable
• The loan is fully amortized, meaning it is paid off at the end of the term

Example: You borrow $100,000 at 10 percent interest with a 5-year term. Your monthly payment is approximately $2,125. After 60 payments, the loan is fully repaid and the account is closed.

How a Line of Credit Works

A business line of credit provides access to a revolving pool of funds that you can draw from as needed, repay, and draw from again. You only pay interest on the amount you have actually drawn, not the full credit limit. The line remains open for you to use repeatedly during the draw period.

Structure:

• You are approved for a maximum credit limit (e.g., $100,000)
• You draw funds as needed in any amount up to the limit
• You pay interest only on the outstanding balance
• As you repay, the available credit replenishes
• The line of credit remains open during the draw period (typically 12 to 24 months, renewable)

Example: You have a $100,000 line of credit. You draw $30,000 for inventory. You pay interest on $30,000 while the remaining $70,000 sits available. When you repay $20,000, your outstanding balance drops to $10,000 and your available credit rises to $90,000.

Side-by-Side Comparison

Cost of Capital

Term loans: Interest accrues on the full loan amount from day one. However, fixed rates and predictable payments make budgeting straightforward. Total interest cost is known at the time of borrowing.

Lines of credit: Interest accrues only on drawn amounts, which can significantly reduce total interest cost if you do not need the full amount at all times. However, variable rates are more common, which means your cost can change.

Verdict: Lines of credit cost less if your funding needs are intermittent. Term loans cost less per dollar for large, one-time investments where you need the full amount.

Flexibility

Term loans: Low flexibility. You receive a fixed amount, make fixed payments, and cannot access additional funds without applying for a new loan. Early repayment may trigger prepayment penalties with some lenders.

Lines of credit: High flexibility. You draw only what you need, when you need it. Repay and re-draw as your cash flow allows. This revolving structure is ideal for businesses with variable or unpredictable funding needs.

Verdict: Lines of credit offer significantly more flexibility.

Predictability

Term loans: High predictability. Fixed payments on a fixed schedule make cash flow planning easy. You know exactly what you owe each month for the life of the loan.

Lines of credit: Lower predictability. Payments vary based on how much you have drawn and the current interest rate. This requires more active financial management.

Verdict: Term loans are more predictable, which simplifies budgeting and financial planning.

Qualification

Term loans: Qualification depends on credit score, revenue, time in business, and the purpose of the loan. SBA term loans have specific eligibility requirements. Conventional term loans from banks require strong financials.

Lines of credit: Similar qualification criteria to term loans, though lenders may be slightly more conservative because they are extending open-ended access to capital. Established businesses with consistent revenue have the best access to lines of credit.

Verdict: Both have similar qualification requirements. Businesses with less than two years of history may find term loans easier to access than revolving credit.

Best Use Cases

Term loans are best for:

• Purchasing equipment with a defined cost
• Funding a renovation or build-out with a fixed budget
• Acquiring a business or commercial real estate
• Any large, one-time investment with a known price tag

Lines of credit are best for:

• Managing seasonal cash flow fluctuations
• Covering payroll during revenue gaps
• Purchasing inventory in variable quantities
• Handling unexpected expenses without applying for new financing
• Bridging the gap between invoicing and payment collection

Can You Have Both?

Yes, and many businesses do. A common strategy is to use a term loan for a specific large investment (equipment purchase, renovation, acquisition) and maintain a line of credit for ongoing operational flexibility. This combination gives you the predictability of fixed payments for major expenses and the flexibility of revolving credit for day-to-day cash management.

Example: A restaurant owner takes a $150,000 term loan to fund a kitchen renovation and maintains a $50,000 line of credit for seasonal inventory purchases and payroll gaps. The term loan payments are fixed and budgeted. The line of credit is drawn during slow months and repaid during busy months.

Decision Framework

Ask yourself these three questions:

1. Do I know the exact amount I need?

• Yes, and it is a one-time need → Term loan
• No, or the amount will vary over time → Line of credit

2. Is this a single investment or an ongoing need?

• Single investment (equipment, renovation, acquisition) → Term loan
• Recurring need (inventory, payroll, seasonal gaps) → Line of credit

3. Do I prefer fixed payments or flexibility?

• Fixed payments for easier budgeting → Term loan
• Draw-and-repay flexibility → Line of credit

If you answered with a mix, consider using both products together.

Apply Through Brevo Capital

Whether you need a term loan, a line of credit, or both, Brevo Capital connects you with lending partners who offer both products. Our matching process evaluates your business profile and funding needs to recommend the right structure.

Apply now and compare term loan and line of credit options for your business.

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Frequently Asked Questions

Which has lower interest rates, a term loan or a line of credit?

Term loans typically have slightly lower interest rates because the lender knows exactly when and how the loan will be repaid. Lines of credit may carry rates 1 to 3 percentage points higher to account for the flexibility and revolving nature of the product. However, total interest cost may be lower with a line of credit if you only draw small amounts intermittently.

Can I convert a line of credit into a term loan?

Some lenders offer term-out options that convert an outstanding line of credit balance into a fixed-term loan. This can be useful if you have drawn a large amount and want the predictability of fixed payments. Ask your lender about this option before opening a line of credit.

Do lines of credit require collateral?

Not always. Many unsecured lines of credit are available for businesses with strong revenue and credit profiles. Secured lines of credit, backed by business assets or a personal guarantee, offer higher limits and lower rates. The choice depends on your financial position and how much credit you need.

What happens when my line of credit draw period ends?

Most business lines of credit are renewable. At the end of the draw period (typically 12 to 24 months), the lender reviews your financials and renews the line. If your business is performing well, renewal is usually straightforward. Some lenders offer evergreen lines that automatically renew unless either party opts out.

Can a startup get a term loan or line of credit?

Startups face challenges with both products but may access SBA microloans (a type of term loan up to $50,000) and small lines of credit from alternative lenders. Revenue-based financing is another option for startups with at least three to six months of revenue. Through Brevo Capital, startups with operating history can explore matched options from multiple lenders.