If you’ve considered obtaining debt financing to invest in your small business and you’re confused about whether to obtain a loan or line of credit, this article will help you understand the difference between the two so you can choose the best option. The chart below outlines the basic differences between loans and lines of credit.
Knowing whether a loan or line of credit is best for you depends on your unique situation, your needs, and how you plan to manage your debt. Now that you have reviewed and understand the major differences between the two, ask yourself the following questions to determine if a loan or line of credit is right for you:
1. Do I need financing for more than one business expense or do I need it for a specific (sole) purpose? Chances are if you need financing for more than one purpose, a line of credit can be a good fit for you. Lines of credit can work best when you need to cover the cost of multiple business expenses (e.g. payroll and inventory purchases) and when the use will be primarily for short term purposes. If you need financing for one (large) purchase (e.g. equipment or machinery), a term or installment loan with a fixed number of payments will probably make more sense.
2. Can I handle a monthly debt payment? If so, how much can I afford to pay? If you can handle a fixed monthly payment over a long period of time a loan can be a good fit for you. However, if you can’t handle ongoing monthly payments over a long time period, you may want to consider a line of credit since the monthly payment can vary (and is often smaller than a loan) depending on how frequently you use it. As the infographic says, loans will bring with them higher monthly payments than lines of credit.
3. How important are interest rates to me? Does it matter to me whether the interest is fixed or variable? If you are comfortable with paying a monthly payment at a fixed interest rate over a long period of time, a loan could work best for you. However, if you prefer lower monthly payments that could vary from month to month (depending on your usage), a line of credit could work better for you. Remember, loans tend to be more rate-driven whereas lines of credit [even though the rates are normally lower] do not tend to be as rate-sensitive.
If you’ve answered the questions above and you’re still confused about whether a loan or line of credit is right for you, the next step would be to consult with an expert who is familiar with the pros and cons of both. The experts at Hawkeye Management fully understand the differences between loans and lines of credit and may be able to assist you with determining the best option for you.