Why this matters

Choosing the right financing affects near-term cash flow, the total cost of borrowing, and whether financing supports predictable investments or flexible working capital needs. In my 15 years advising small businesses, I’ve seen the wrong match increase financing costs and strain operations; the right match preserves liquidity and lowers effective interest expense.

Quick side-by-side

  • Revolving credit line: flexible borrowing up to a credit limit; interest only on the drawn amount; can be renewed or reduced by the lender.
  • Term loan: fixed (or variable) loan amount repaid over a set amortization schedule; predictable principal-and-interest payments.

Costs: how they differ

  • Interest calculation: Revolving lines charge interest on the outstanding balance only; the rate is often variable and tied to a benchmark such as the prime rate. Term loans may have fixed or variable rates and interest accrues on the full principal from day one.

  • Fees: Lines often carry maintenance fees, unused-line fees, or renewal fees. Term loans commonly include origination or closing fees and sometimes prepayment penalties. Always ask for an itemized fee schedule.

  • Effective cost: For short-term borrowing where you repay quickly, a line can be cheaper because you don’t pay interest on undrawn capacity. For long-term, large investments, term loans can be cheaper because they can lock in a lower fixed rate and spread fees across many payments.

Lender requirements and risks

  • Covenants and monitoring: Both products may include covenants (financial reporting, minimum liquidity). Lines are more likely to have periodic reviews and renewal risk—the lender can reduce or cancel the line at renewal.

  • Collateral: Both can be secured or unsecured. Lenders typically require stronger collateral or personal guarantees for larger amounts or weaker credit profiles.

Use cases and examples

  • Best uses for revolving lines: seasonal inventory, payroll timing gaps, short-term supplier discounts, emergency cash. Example: a retail client I advised drew against a line during holiday inventory buildup, then repaid it after sales cleared, minimizing interest.

  • Best uses for term loans: equipment purchases, real estate, business acquisitions, or any planned expenditure where predictable repayments match the asset’s useful life.

  • Hybrid strategies: Many businesses keep a small undrawn line for emergencies and use term loans for major fixed investments.

How lenders price and what to ask

  • Ask whether the rate is fixed or variable, the benchmark (prime, SOFR), and how often the rate reprices.
  • Request an APR-equivalent or an amortization schedule showing total interest and fees for comparability.
  • For lines, ask about renewal policies and any unused-line or commitment fees.

Tax treatment and recordkeeping

Interest paid on business loans is generally deductible when the debt funds ordinary and necessary business activity (see IRS Publication 535) ((https://www.irs.gov/publications/p535)). Keep clear records of use and purpose to support deductibility.

Choosing between them: a short checklist

  • Time horizon: Short-term operational gap → line. Long-term asset → term loan.
  • Cost predictability: Need fixed monthly cost → term loan. Need borrowing flexibility → line.
  • Cash flow volatility: If cash swings, a line can smooth operations. If cash is steady and you can service a schedule, a term loan can be less costly over time.

Practical steps to apply

  1. Prepare recent financials, bank statements, tax returns, and a cash-flow projection showing how you’ll use and repay funds.
  2. Compare offers by APR, fees, covenants, and collateral requirements—not just advertised rates.
  3. Negotiate line size, renewal terms, and fee waivers where possible.

Common mistakes to avoid

  • Treating a line like free money; unused commitment fees or high variable rates can be costly if you draw often.
  • Using a term loan for short-term working capital; paying interest on the entire principal while cash sits idle raises costs.

Further reading and resources

Professional disclaimer

This article provides general information for educational purposes and not personalized financial advice. For a customized recommendation, consult a CPA, commercial lender, or certified financial advisor familiar with your business.