Quick overview

Lines of credit give flexible access to funds you can draw, repay, and redraw up to a limit. Term loans deliver a single, fixed amount repaid over a set period. The right choice depends on timing, predictability of cash flow, and the purpose of the funds.

When a line of credit is the better choice

  • Cash-flow gaps and working capital: Use a line to bridge payroll, inventory purchases, or seasonal revenue shortfalls.
  • Unpredictable or intermittent needs: If spending is irregular, a line avoids paying interest on unused capital.
  • Short-term, lower-cost needs: Draws often carry variable interest and you only pay interest on amounts used.
  • Emergency runway: Keeps a flexible safety buffer without taking on long-term debt.

Real example: a retail owner draws to pre-buy holiday inventory and repays from seasonal sales.

When a term loan is the better choice

  • Large one-time investments: Equipment, facility expansion, or acquisition are suited to term loans.
  • Predictable repayment plan: Fixed payments help with budgeting and can lock a fixed interest rate.
  • Lower long-term interest risk: Fixed-rate term loans protect against rising rates.
  • Better for credit-building: Long-term, consistently repaid loans can strengthen business credit profiles.

Real example: a manufacturer takes a term loan to buy a production line with a five-year repayment schedule.

Cost and structure differences to watch

  • Interest: Lines usually have variable rates; term loans often offer fixed or fixed-for-a-period rates.
  • Fees: Lines can include maintenance, non-use, or draw fees; term loans may include origination fees.
  • Repayment: Lines allow flexible repayments (interest-only or principal+interest); term loans require scheduled principal payments.
  • Covenants and collateral: Both may require collateral or personal guarantees—SBA-backed term loans frequently have explicit collateral rules (see SBA guidance).

How to decide—practical checklist

  1. Define purpose: short-term working capital vs capital investment.
  2. Forecast cash flow: can you support fixed monthly payments? If not, prefer a line.
  3. Compare total cost: include fees, rate type, and expected time to repay.
  4. Consider timing: need funds immediately and intermittently → line; need a lump sum now → term loan.
  5. Check qualification: lenders evaluate cash flow, collateral, and credit history.

Using both strategically

Many growing firms use a line for day-to-day working capital and a term loan for long-term assets. Maintain conservative utilization of a line to keep borrowing capacity and protect credit scores.

Common mistakes

  • Treating a line like free cash: Overuse can create a debt spiral if revenue doesn’t materialize.
  • Mixing uses: Financing permanent assets with a line raises refinancing risk.
  • Ignoring fees and renewal terms: Lines can be closed or reduced at renewal.

Short scenarios

  • Seasonal retailer: Line of credit for inventory; term loan for a new retail location.
  • Service firm with steady contracts: Term loan for office build-out; line for timing gaps in receivables.

Where to learn more and related guides

See our deeper comparisons and qualification guides for practical next steps: Business Line of Credit vs Term Loan: When to Use Each, Small Business Line of Credit: When to Use It and How to Qualify, and How a Business Line of Credit Differs from a Term Loan.

Authoritative sources

  • U.S. Small Business Administration — guides on business financing and SBA loan types (sba.gov).
  • Consumer Financial Protection Bureau — information on small-business lending and comparing loan offers (consumerfinance.gov).

Professional disclaimer

This content is educational and not personalized financial advice. Consult a CPA, lender, or financial advisor about your business’s situation before borrowing.