Quick answer

For projects with defined, one-time costs (equipment, real estate, major expansion), a term loan is usually the better match because it provides a lump sum and predictable payments. For projects that require flexible timing, phased spending, or backup liquidity (inventory spikes, marketing ramps, working capital), a business line of credit offers lower-cost flexibility. Many businesses use both: a term loan for the capital investment and a line to manage cash-flow variability.

How each product works (short primer)

  • Business line of credit: a revolving credit facility with a maximum limit. You draw, repay, and redraw during the term. Interest accrues only on the outstanding balance. Lenders may charge a facility fee, maintenance fee, or a draw fee. Lines can be secured (assets, receivables) or unsecured; secured lines typically offer larger limits and lower rates. See our deep dive on Business Line of Credit.

  • Term loan: a one-time lump-sum loan paid back in fixed installments over a set term (commonly 1–10 years for small business loans). Rates can be fixed or variable. Term loans suit capital expenditures with clear, measurable ROI. The U.S. Small Business Administration documents common loan programs and terms you’ll encounter (SBA).

(Author note: In my 15+ years advising businesses, I’ve seen startups use small unsecured lines to bridge early receivable gaps while established firms take 3–7 year term loans for equipment and capacity-building projects.)

When to choose a business line of credit

  • Need for flexible, on-demand cash: If your growth project breaks into stages or has unpredictable timing, a line lets you draw only what’s needed.
  • Short-term funding horizon: Lines are cost-effective for needs expected to be repaid in months rather than years.
  • Managing working capital: Seasonal businesses use lines to stock inventory or fund payroll during slow periods.
  • Lower immediate borrowing costs: Because interest is charged only on draws, short-term usage can be cheaper than a term loan with immediate amortization.

Real example: A marketing firm drew $40,000 from its line to fund a campaign with staggered vendor payments, repaying it within four months after client fees cleared. That flexibility avoided a larger, longer loan that would have incurred unnecessary interest.

When to choose a term loan

  • One-time, capital-heavy purchase: Buying equipment, commercial property, or financing renovations that create a long-term asset.
  • Predictable repayment ability: If you can project cash flows to cover fixed payments, a term loan locks in discipline and often lower interest for long-term use.
  • Lower total financing cost for long-term needs: Fixed or competitively priced variable rates on longer terms can be cheaper than repeatedly drawing on a line.

Real example: A small manufacturer took a 5-year term loan to buy a cutting machine. The loan’s amortization matched depreciation and sales growth, keeping monthly payments within budget.

Key features to compare (what matters to lenders and owners)

  • Availability: A line gives immediate access up to the limit; a term loan pays out once after funding approval.
  • Interest: Lines are usually variable; term loans can be fixed or variable. Compare APRs, not just headline rates.
  • Fees: Lines often have maintenance or unused-line fees; term loans may include origination fees and prepayment penalties.
  • Collateral & covenants: Term loans and secured lines often require collateral and financial covenants (coverage ratios, minimum DSCR). Unsecured lines have higher rates.
  • Repayment structure: Lines typically require interest-only or minimum payments on outstanding balances; term loans amortize principal and interest.
  • Renewal/term length: Lines can be renewable (annual reviews); term loans have fixed maturities.

Tax and accounting considerations

Interest on business loans is generally deductible as an ordinary and necessary business expense under IRS rules when the loan proceeds are used for business purposes (see IRS — Deducting Business Expenses). Keep clear records of how funds are used: the deduction depends on the purpose (capitalized asset costs may be depreciated instead of expensed). If you use a line to buy capital equipment, you may need to capitalize and depreciate the asset rather than deduct the full interest immediately. Consult your tax advisor for treatment specific to your use case.

Eligibility and qualification (what lenders look for)

Common lender requirements include:

  • Business history and revenue: Established firms with 2+ years of demonstrated revenue have a stronger case for term loans; some lenders offer lines to newer firms but often at higher cost.
  • Business credit score and personal guarantees: For small businesses, owner creditworthiness matters—expect personal guarantees for many loans.
  • Cash flow and debt coverage: Lenders review debt-service coverage ratio (DSCR) and cash flow projections for term loans.
  • Collateral and documentation: Tax returns, financial statements, bank account statements, business plan, and contracts or invoices for accounts-receivable financing.

For practical guidance on qualification and positioning, see our article on How to Position Your Business for a Line of Credit Approval.

Risks and common mistakes

  • Over-borrowing: Taking a larger line or loan than you need increases interest costs and the chance of covenant breaches.
  • Using the wrong tool: Financing a durable capital purchase with a short-term line can create unnecessary refinancing risk.
  • Ignoring total cost: Unused-line fees, draw fees, balloon payments, or prepayment penalties can change the economics dramatically.
  • Poor tracking of use: Mixing personal and business uses or failing to document purpose creates accounting and tax headaches.

A practical decision checklist (step-by-step)

  1. Define the project scope: one-time vs phased; total cost and timing.
  2. Create a 12–36 month cash-flow projection showing monthly inflows and outflows.
  3. Estimate how much you’ll need immediately vs later — if >50% is immediate and one-time, favor a term loan.
  4. Compare APRs, fees, and collateral requirements from 2–3 lenders for both product types.
  5. Evaluate flexibility needs: Will you need to re-borrow or adjust spend timing? If yes, favor a line.
  6. Consider blended financing: term loan for the capital asset + line for working capital/backstop.

Blended strategy example

A restaurant owner needed $120,000 to remodel the kitchen and $30,000 to cover inventory and staffing while the new menu rolled out. The owner took a 7-year term loan for $120,000 at a competitive fixed rate and kept a $30,000 revolving line to handle weekly cash-flow swings until revenue stabilized. This combination limited long-term interest costs while preserving short-term flexibility.

Application tips (speed and cost control)

  • Prepare organized financials: 2–3 years of tax returns, current balance sheet, P&L, and 3–12 months of bank statements.
  • Shop multiple lenders: community banks, credit unions, and online lenders offer different pricing and speed. Smaller local banks sometimes offer more flexible covenant terms.
  • Negotiate fees and prepayment terms: ask for waived origination fees or the ability to prepay without penalty.

Frequently asked questions (brief)

  • Can I convert a line balance into a term loan? Yes; many lenders offer a conversion feature (called a ‘‘term-out’’) to turn a revolving balance into a fixed-term loan when you want stable payments.
  • Which has better rates? Historically, secured term loans often have the lowest long-term rates; unsecured lines carry higher rates. Compare APRs from offers.
  • Are both deductible? Interest may be deductible for business use (see IRS guidance), but treatment can differ if the loan buys a depreciable asset.

Conclusion and next steps

Match the financing structure to the economics and timing of the project. If the cost is predictable and long-lived, favor a term loan; if timing and cash needs will ebb and flow, a line of credit is often superior. When in doubt, run both scenarios in a cash-flow model and include fees and taxes in your comparisons.

Internal resources and further reading

  • Read our primer on the core product: Business Line of Credit (link).
  • For a head-to-head comparison, see Business Line of Credit vs Term Loan: When to Use Each (link).
  • If you’re weighing multiple loan offers, our Business Loans: Choosing Between Term and Line of Credit article helps compare lender types and fees (link).

Professional disclaimer

This article is educational and not individualized financial or tax advice. For decisions that affect your business’s financial position, consult a qualified accountant or commercial lender. In my advisory practice I always recommend running pro forma cash flows and discussing tax treatment with your CPA before signing loan documents.

Sources and authoritative references

(Internal links used: Business Line of Credit: https://finhelp.io/glossary/business-line-of-credit/, Business Line of Credit vs Term Loan: When to Use Each: https://finhelp.io/glossary/business-line-of-credit-vs-term-loan-when-to-use-each/, Business Loans: Choosing Between Term and Line of Credit: https://finhelp.io/glossary/business-loans-choosing-between-term-and-line-of-credit/.)