Quick summary

Term loans and revolving lines of credit are two of the most common financing options for growing businesses. Each has clear strengths: term loans for one-time capital projects and predictable budgets, and revolving lines for flexible working capital and seasonal needs. This guide explains how each works, compares costs and risks, and gives a practical checklist to help you choose.

How term loans work

  • You receive a single lump sum up front and repay it over a fixed term (for example, 1–10 years) with a scheduled payment plan.
  • Interest is typically fixed or variable but is often locked for the term with installment amortization.
  • Lenders commonly require collateral (equipment, real estate) and may request a personal guarantee from the owner.
  • Term loans are well suited to purchases with a clear useful life—equipment, real estate, renovations, or financing a concrete expansion.

Example: a $100,000 term loan at 6% amortized over 4 years has a monthly payment of roughly $2,353 and total interest of about $12,940 over the life of the loan. That predictability can make budgeting and forecasting simpler.

How revolving lines of credit work

  • Lenders approve a maximum credit limit (for example, $50,000). You draw funds as needed, repay, and borrow again up to the limit.
  • You pay interest only on the outstanding balance. Lines often have variable rates tied to an index (prime), plus fees such as an annual facility fee.
  • Lines of credit are best for short-term working capital: payroll gaps, seasonal inventory purchases, slow receivable periods, and unexpected expenses.

Example: a business with a $50,000 line that averages a $30,000 balance for nine months at an 8% interest rate would pay roughly $1,800 in interest for that usage period, plus any facility fees.

Cost comparison and effective interest

When comparing costs, look beyond the headline rate:

  • Amortization and term affect total interest on term loans. Longer terms lower monthly payments but increase total interest.
  • Revolving lines may appear cheaper when used briefly but can become more expensive if balances remain high for long periods because rates are often variable and lines sometimes carry ongoing fees.
  • Calculate effective annual cost (interest + fees) for a realistic scenario: estimate average balance for a line; for a term loan, calculate amortized payments. Compare total interest across the same time window.

Practical tip: Ask lenders for an APR or an annualized cost example based on realistic usage. The Consumer Financial Protection Bureau and most reputable lenders will provide estimates to help you compare (CFPB).

Risk, covenants, and collateral

  • Term loans frequently include covenants (minimum cash, debt-service coverage ratio) and collateral tied to the loan purpose. Violating covenants can trigger default.
  • Lines of credit may be unsecured for smaller limits, but larger lines often require a blanket lien on business assets, accounts receivable, or inventory. Lenders also commonly require personal guarantees.
  • Revolving facilities may be subject to periodic reviews and can be reduced or canceled if the borrower’s financial condition worsens, creating liquidity risk.

In short: a term loan usually gives longer security to the borrower (fixed payments and time horizon) but locks you into repayment. A line gives flexibility but less payment certainty and potential renewal or reduction risk.

Tax and accounting considerations

  • Interest on business loans is generally deductible as a business expense when the debt is used for business purposes (see IRS Publication 535 on business expenses). Limitations under Internal Revenue Code Section 163(j) still apply in some circumstances; consult your tax advisor for specifics (IRS).
  • Capitalized assets bought with a term loan may be depreciated rather than fully expensed in the year of purchase—this affects cash-tax planning.

Always check with a CPA for current tax rules and how a financing decision will affect your taxable income and cash flow.

Which businesses benefit most from each option

  • Term loans are best when:

  • You need a substantial, one-time amount (equipment, real estate, major renovation).

  • You want predictable monthly payments for budgeting.

  • The purchase has a useful life that matches the loan term.

  • Revolving lines are best when:

  • Cash flow is cyclical or unpredictable (seasonal retail, agriculture, services with long receivable cycles).

  • You need an emergency liquidity buffer or short-term working capital.

  • You prefer interest only on the funds you actually use.

Many growing businesses use both: a term loan for capital projects and a line of credit for operating fluctuations. See our practical comparison Business Line of Credit vs Term Loan: When to Use Each for more on combining options.

Decision checklist: pick the right product

  1. Define the purpose: capital asset or working capital?
  2. Project cash flow: can you handle fixed monthly payments?
  3. Estimate term: short-term need → line; multi-year investment → term loan.
  4. Model cost: include interest, fees, covenants, and potential renewal risk.
  5. Check collateral and guarantees: are you willing to pledge assets or sign a personal guarantee?
  6. Ask lenders for amortization schedules and an APR example for both products.
  7. Consider timing and availability: SBA-backed or bank term loans take longer to close than many lines.

If you need help packaging a loan request, our guide on SBA 7(a) vs Community Bank Term Loans: Which Fits Your Business? explains how different term loans are structured and what lenders expect.

Common mistakes I see in practice

  • Using a line of credit for a long-term purchase. Lines are cheaper short-term, but carrying high balances long-term can cost more than a term loan and hurt relationships with lenders.
  • Failing to model covenant triggers. A loan that looks affordable on paper can become precarious if sales dip and covenants tighten.
  • Overlooking fees: unused-fee, non-use fees, annual fees, and prepayment penalties can change the economics.

Sample scenario that illustrates the choice

Business A needs $150,000 to buy equipment that will be used for five years. A 5-year term loan at a fixed rate lets them match the asset life to the payment schedule and preserves a line of credit for seasonal payroll.

Business B is a retailer with seasonal inventory needs. A $75,000 revolving line lets them draw for inventory seasons and repay during peak sales, avoiding long-term debt for short-term cycles.

Both are valid. Structure matters: use the term loan for assets, the line for working capital.

Next steps and practical tips

  • Prepare clear financial statements, a cash-flow forecast, and a one-page explanation of how you’ll use the funds.
  • Shop multiple lenders and compare amortization schedules, APRs, and fees—not just advertised rates.
  • Consider SBA CAPLines or other short-term SBA options if you need a line of credit with favorable terms (SBA).
  • Talk to your CPA or loan officer about tax treatment and whether debt proceeds should be capitalized.

Resources and authoritative references

Professional disclaimer: This article is educational and does not replace individualized financial, tax, or legal advice. Consult a qualified lender, CPA, or attorney before making financing decisions.

For deeper reading on lines of credit and term loans, see our related articles: “Business Line of Credit vs Term Loan: When to Use Each” and “SBA 7(a) vs Community Bank Term Loans: Which Fits Your Business?” linked above.