How a Business Line of Credit Differs from a Term Loan

Quick overview

A business line of credit and a term loan both provide capital, but they solve different problems. Lines of credit are designed for variable, short-term needs—seasonal payroll, inventory timing gaps, or emergency cash. Term loans are structured for single, larger purchases such as equipment, real estate improvements, or long-term growth projects where predictable repayment is advantageous.

This article explains the structural differences, typical costs and fees, how lenders underwrite each product, when to choose one over the other, tax and accounting considerations, and practical selection tips based on real-world experience.

(If you want deeper reads on related topics, see our guides: Business Line of Credit, Choosing Between Term Loans and Lines of Credit for Your Business, and How Business Lines of Credit Work for Cash Flow Management.)

Head-to-head: core differences

How lenders price and underwrite each product

• Underwriting focus for lines of credit: cash flow volatility, bank statements, business checking activity, and a shorter operating history can still qualify if cash flow is steady. Lenders look for a reliable repayment source because the borrower can draw multiple times. (See SBA guidance on short-term working capital.)
• Underwriting for term loans: lenders emphasize collateral value (machinery, property), business and personal credit scores, profit history, and debt-service coverage ratios. Term loans often require more documentation and stronger financial statements.

Interest rates for lines are frequently variable and tied to an index (prime + spread). Term loans can have fixed or variable rates; fixed rates offer predictability but may be higher initially. Online and non-bank lenders may charge higher base rates but faster approval timelines.

Fees differ materially. A line may carry an annual fee, inactivity fee, or unused-commitment fee. Term loans commonly include origination or closing fees and sometimes prepayment penalties.

Uses and real-world examples (practical insights)

• Example 1 — Seasonal retailer: I worked with a boutique that had a predictable holiday sales surge. A $75,000 line of credit covered inventory buys and payroll in October–December. They drew only what they needed and repaid from holiday receipts, paying interest on the draws only.
• Example 2 — Manufacturing equipment purchase: A mid-sized manufacturer needed a new press. A 5-year term loan provided $250,000 at a set amortization schedule. The predictable payment helped the owner budget and match the asset’s useful life with the loan term.

These examples illustrate a central principle I use with clients: match the loan structure to the cash-flow pattern and the asset’s useful life.

Eligibility and documentation: what lenders ask for

• Line of credit checks: 6–24 months of bank statements, recent tax returns, business revenue trends, and sometimes a personal guarantee. Shorter track records can be acceptable with stronger ongoing cash flow.
• Term loan checks: business financial statements (balance sheet, P&L), tax returns for 2–3 years, collateral appraisals when relevant, and personal guarantees.

Tip from my practice: maintain clean, separated business bank accounts and up-to-date financial statements—those documents shorten underwriting time and improve pricing.

Tax and accounting considerations

• Interest: Business interest on both lines and term loans is generally deductible as a business expense when the debt is used for business purposes. Tax rules have nuances—large corporations face business interest limitations under the Internal Revenue Code, and some exceptions apply to small businesses. Always check IRS guidance and consult your tax advisor. (See IRS Publication 535 for business expenses.)
• Balance sheet treatment: A line’s outstanding balance is reported as short-term debt if due within a year (unless classified differently), while term loans are split between short- and long-term portions based on the amortization schedule.

Pros and cons at a glance

• Business line of credit
• Pros: flexibility, pay interest only on draws, supports ongoing working capital, quick access once established.
• Cons: variable rates, possible unused fees, potential temptation to borrow for non-essential needs.
• Term loan
• Pros: predictable payments, often lower fixed rates for well-qualified borrowers, good for matching asset life to loan term.
• Cons: less flexible, interest cost begins on the full principal, may have origination fees and stricter covenants.

When to choose which (decision checklist)

• Choose a business line of credit if:

• You need ongoing access or expect variable cash flow timing.

• You want to borrow only what you use and avoid paying interest on undrawn capital.

• You need a safety net for short-term gaps.

• Choose a term loan if:

• You’re financing a defined purchase (equipment, real estate improvement) with a predictable repayment source.

• You want fixed monthly payments for budgeting certainty.

• You need a larger, one-time sum and can justify amortizing that cost over several years.

In practice, companies often use both: a line for day-to-day working capital and a term loan for long-lived assets.

Common mistakes and how to avoid them

• Mistake: Treating a line like free cash. Fix: Build drawing rules—only use the line for planned temporary gaps or approved opportunities.
• Mistake: Ignoring fees and true cost. Fix: Calculate APR equivalents where possible and include unused-commitment fees.
• Mistake: Choosing the cheapest immediate rate without considering repayment flexibility or covenants. Fix: Model cash flow under stress scenarios.

How to negotiate better terms

• Improve your balance sheet and clean up business banking records before applying.
• Shop multiple lenders—community banks, credit unions, online lenders, and SBA programs all price differently. (SBA guidance can be helpful for certain loan products.)
• Ask about converting a line to a term loan or vice versa; some lenders allow refinancing or conversion when needs change.

Frequently asked practical questions

• Can a line of credit be converted to a term loan? Yes—many lenders offer conversion or refinancing into a term loan once the outstanding balance justifies that structure.
• Will a line affect my credit profile the same way as a term loan? Both can impact business and personal credit depending on whether personal guarantees were used; lines with large unused commitments can show on reports differently.
• Are there SBA programs that help? Yes—SBA CAPLines and other SBA-backed working capital programs are structured lines and loans designed for small-business cash needs. See SBA.gov for program specifics.

Action steps for business owners

1. Document your funding need: amount, timing, and repayment source.
2. Gather financial documents: bank statements, recent P&Ls, and tax returns.
3. Compare quotes from at least three lenders and ask for an itemized list of fees and sample amortization schedules.
4. Consult your accountant to confirm tax treatment and an advisor to ensure the loan type matches your cash-flow profile.

Authoritative sources and further reading

• Consumer Financial Protection Bureau (CFPB) guidance on small business lending practices: https://www.consumerfinance.gov/ (CFPB)
• U.S. Small Business Administration: information on working capital and CAPLines: https://www.sba.gov/ (SBA)
• IRS Publication 535 — Business Expenses (interest deductions): https://www.irs.gov/ (IRS)

Final notes and professional disclaimer

In my experience advising small and mid-sized businesses, the most successful financing plans start with a clear match between the purpose of the funds and the loan structure. Use a line of credit to smooth irregular cash flow and a term loan to finance long-lived investments.

This article is educational and does not replace personalized legal, tax, or lending advice. Consult a licensed financial advisor or lender to review your specific situation before borrowing.