How each product works

  • Line of credit (LOC): a revolving source of funds you can draw, repay, and draw again up to a credit limit. Interest is charged only on the outstanding balance; many business LOCs have variable rates and a renewal or review at the end of the term. LOCs act like a business checking buffer for timing gaps in receivables or seasonal buying needs. (See CFPB guidance on revolving credit for consumers: https://www.consumerfinance.gov)

  • Term loan: a fixed principal paid out once and repaid in scheduled installments (monthly, quarterly, etc.) over a set term. Rates can be fixed or variable; repayment schedules reduce principal over time and are suited for purchases where you can forecast cash flow (equipment, real estate, vehicle). Small Business Administration resources explain common term‑loan structures: https://www.sba.gov

When to choose a line of credit

  • Your cash needs are short‑term or unpredictable (payroll swings, inventory buildup, seasonal demand). A LOC provides flexibility and lower interest cost when you only borrow intermittently.
  • You need an on‑demand liquidity buffer rather than a fixed repayment plan.
  • You expect multiple draws and paydowns over time rather than one one‑time capital purchase.

In my practice advising small businesses, I recommend LOCs for clients with variable receivables who want to avoid high‑cost short‑term options like merchant cash advances.

When to choose a term loan

  • You’re financing a specific asset or project with predictable cash flows (new equipment, vehicle, expansion, property acquisition).
  • You prefer predictable monthly payments to simplify budgeting and amortize the cost of the asset.
  • You can secure better pricing with a longer term or a lower fixed rate.

For capital investments that increase earning capacity, a term loan usually matches the life of the asset with repayment timing.

Cost, collateral, and eligibility — practical points to compare

  • Interest: LOCs are commonly variable; term loans often offer fixed‑rate options. Variable rates can be cheaper initially but add interest‑rate risk.
  • Fees: LOCs may carry commitment or renewal fees, unused line fees, and higher admin costs. Term loans may include origination fees and prepayment penalties—compare APR, not just headline rate.
  • Collateral & covenants: Both products can be secured; lenders may require personal guarantees or UCC filings for business lines. Startups often get smaller LOCs or unsecured term loans with stricter covenants.
  • Qualification: lenders evaluate credit score, cash flow, debt service coverage, and business history. The SBA and CFPB provide borrower guides on loan considerations (https://www.sba.gov; https://www.consumerfinance.gov).

Real‑world examples

  • Seasonal retailer: uses a LOC to buy inventory ahead of holiday demand, repaying as sales come in (see our guide on using lines of credit for seasonal cash flow).
  • Construction firm: takes a term loan to buy a vehicle or heavy equipment where the debt term matches the asset life.
  • Growing business deciding between an LOC and an SBA 7(a) term loan: compare long‑term cost and covenants — our SBA 7(a) vs Business Line of Credit guide explains tradeoffs.

Quick decision checklist

  • Need ongoing flexibility? Choose LOC.
  • Need capital for a specific asset and want predictable payments? Choose term loan.
  • Concerned about rising rates? Lean toward a fixed‑rate term loan or consider rate caps on LOCs.
  • How will payments affect cash flow? Build a 12‑month cash‑flow forecast before borrowing.

Common mistakes to avoid

  • Using a term loan for unpredictable working capital needs — this can leave you short if revenues dip.
  • Relying on a LOC as your only source of capital without contingency plans; lenders can reduce or close lines on renewal.
  • Focusing only on the nominal interest rate; ignore fees and renewal risks.

Further reading and internal resources

Professional disclaimer

This article is educational and not individualized financial advice. Consult a CPA or lending professional to match product choice to your tax, cash‑flow, and growth objectives.

Authoritative sources