An accident might foist an emergency need to purchase equipment or inventory on you.
You might have accounts receivable that didn’t materialize in good time, you might find an usual opportunity for growth by buying out a smaller rival or launching into a new market. For each of the aforementioned (and more), you’ll need some help in raising the necessary funds.
Two of the major financing options opens to businesses are business loans and lines of credit. A business loan is simply a debt you acquire in order to meet financial needs in a business. A line of credit is a financial arrangement between a business and lender that establish a maximum loan amount that you can access and maintain.
From the definitions, you’ll notice some major differences between business lines and lines of credit. Business owners are often torn between taking business loans or opening lines of credit. This article explores the pros and cons of a line of credit and a business loan.
Line of Credit
- Line of credits provides you with access to ongoing capital that you can draw on when necessary. The fact that a line of credit provides you ongoing access to cash gives you the peace of mind to know that you’ll be able to meet any emergency financial need inasmuch as it doesn’t require a bigger amount of money than the total line of credit.
- Secondly, a line of credit typically carries a variable repayment schedule in which you’ll only pay back any amount of money you draw on the line of credit. If you have a $100,000 line of credit, you don’t have to worry about monthly payments. If you draw $2000 on your line of credit this month, you’ll only be required to pay back that $2000 as opposed to a monthly payment on $100,000. If you don’t draw on your line of credit in a given month, you most likely won’t need to make any payment that month,
- Thirdly, a line of credit typically carries significantly lower costs than other types of financing available to business owners. For instance, a line of credit doesn’t carry an origination fee; hence, you don’t have to pay more than the actual money you borrowed. If you decide that you don’t need the line of credit again, you can expect to pay zero or little closing costs.
- The first major disadvantage of a line of credit is that it doesn’t usually provide easy access to a lump sum of capital as there might be limitations on the percentage of the line of credit that you can draw on in each tranche.
- Most lines of credit require you to pay a “draw fee” every time you withdraw from the account. If the draw fee is $50 and you withdraw funds five times in a month, you’ll have paid $250 in draw fees – the draw fee is different from your payable balance or interest.
- A business loan provides you with access to a lump sum of money that you can apply towards a specific purpose. Business loans provide the best value for long-term capital needs for startup, expansion, or buying/upgrading equipment. You can expend all the money from a business loan on a single purchase; in fact, that is expected of you.
- Another main advantage of business loans is that that it forces financial prudency, which in turn leads to financial stability on a firm. For one, business loans are usually applied towards specific purposes such as buying inventory, equipment, or real estate. Hence, you won’t have surplus cash from the loan that you can splurge on unnecessary expenses. The fact that you have to make fixed monthly payments helps you to plan your business expenses each month in order to ensure that you are not behind in payments.
- Business loans have a fixed repayment structure that often requires you to make regular monthly payments. Failure to make a monthly payment might result into penalties and a drop in your creditworthiness. The worst part is that you’ll still make the same monthly payments even when you have paid a significant part of the loan.
- Secondly, business loans tend to carry higher interest rates and other associated costs. The interest rate a business loan might vary range from 2% to 20% depending on your lender and you’ll be expected to pay the full interest on total loan amount. In fact, you can expect to pay more in interest if you choose to pay off your loan earlier than the term. Business loans also include other fees such as origination fees, early payment penalties, and late-payment fees among other fees.