Background and quick framing

Both products help businesses cover short-term operating needs—payroll, inventory, seasonal swings, or unexpected bills—but they suit different situations. The U.S. Small Business Administration explains common business loan structures and underwriting standards; the Consumer Financial Protection Bureau covers borrower rights and costs for small-business credit lines and loans (SBA: https://www.sba.gov, CFPB: https://www.consumerfinance.gov).

How each option works

  • Working capital loan: You receive a lump sum and repay principal plus interest over a fixed term (often 6 months to 5 years for typical small-business loans). Use cases: inventory buys, equipment closeouts, or a planned expansion. Interest and payments are predictable.

  • Line of credit: The lender sets a credit limit you can draw against, repay, and draw again (revolving). You pay interest only on the outstanding balance and may pay a small annual or maintenance fee. Use cases: smoothing seasonal revenue swings, covering unexpected vendor invoices, or bridging receivables.

Practical examples

  • Retailer (one-time stock purchase): A $50,000 working capital loan provides funds to buy seasonal inventory with a set repayment plan tied to expected sales.

  • Service firm (seasonal revenue): A $75,000 line of credit covers payroll during slow months; interest accrues only on draws and is lower when unused.

When to choose which

  • Choose a working capital loan if:

  • You need a known lump sum for a specific purpose.

  • You prefer fixed payments and predictable budgeting.

  • You can show a repayment plan tied to revenue or a sale.

  • Choose a line of credit if:

  • Your cash needs are irregular or ongoing.

  • You want flexibility and to minimize interest by borrowing only what you need.

  • You need a standby source for emergencies or short gaps.

Costs, qualification, and typical terms

Rates and terms vary widely by lender, credit profile, collateral, and product. Typical ranges for small businesses in recent market conditions (2024–2025) have shown:

  • Working capital loans: rates often from mid-single digits for well-qualified borrowers to high teens for riskier profiles; terms usually 6 months to 5 years.
  • Lines of credit: variable rates that can be slightly lower than unsecured term loans for similar credit, but may include fees (maintenance, draw, or renewal). Revolving terms typically renew annually.

Lenders evaluate: credit score, time in business, revenue, cash flow, and collateral (SBA guidance explains eligibility and required documents). If you’re pursuing an SBA-backed product, review SBA loan programs and documentation requirements at the SBA website (https://www.sba.gov).

Eligibility and documentation

Common lender requirements:

  • 1–2+ years in business (varies).
  • Demonstrable revenue and bank statements.
  • Business and sometimes personal credit scores (personal guarantees are common).
  • Financial statements, tax returns, and a use-of-proceeds plan.

Pros and cons (summary)

  • Working capital loan

  • Pros: predictable payments, single underwriting event, better for planned growth projects.

  • Cons: interest on the full amount from day one, less flexibility if needs change.

  • Line of credit

  • Pros: flexibility, interest only on what you use, good for variable cash flow.

  • Cons: may have ongoing fees, lenders can reduce the limit at renewal, discipline required to avoid chronic borrowing.

Common mistakes and how to avoid them

  • Overborrowing: Don’t take more than you can reasonably service—use a cash-flow forecast. See our guide to preparing working capital forecasts: Preparing Working Capital Forecasts for Loan Applications.

  • Treating a line like free money: Maintain a repayment plan and avoid using a line of credit for recurring structural losses.

  • Ignoring fees: Compare APR, draw fees, renewal or unused-line fees, and prepayment penalties.

Internal resources

Quick decision checklist

  • Is the need one-time and planned? → Lean toward a working capital loan.
  • Is the need recurring or unpredictable? → Lean toward a line of credit.
  • Can you pass basic lender tests (revenue, credit, docs)? → Shop lenders and ask about fees and covenants.

Frequently asked question (short answers)

  • Can a business have both? Yes—many businesses use a term loan for a capital project and a line of credit for day-to-day liquidity.
  • Will a line of credit hurt my credit? Properly managed, it can help build credit; missed payments or high utilization can harm it (CFPB overview: https://www.consumerfinance.gov).

Next steps and professional advice

Run a short cash-flow forecast covering 6–12 months, list the timing and size of expected cash gaps, and compare quotes from multiple lenders (bank, credit union, online lender). Consider working with a certified financial advisor or accountant to model scenarios and tax implications.

Disclaimer

This article is educational and not personalized financial advice. For tailored guidance, consult a licensed financial professional or your lender. Authoritative sources used: U.S. Small Business Administration (https://www.sba.gov) and Consumer Financial Protection Bureau (https://www.consumerfinance.gov).