Business Line of Credit vs. Term Loan: Which Fits Your Business?

If your business needs money, you may be looking at a line of credit and a term loan. Both can help you pay for business needs, but the way you get and repay the money is different. Knowing when you will need the funds, and when you expect money to come back into the business, can help you choose which option to explore.

The short answer: A business line of credit gives you access to money up to an approved limit. Depending on the agreement, you can take some out, pay it back and use it again. A term loan usually gives you a set amount upfront, which you repay over an agreed period. A line of credit can suit expenses that come and go, while a term loan can suit a planned expense with a more predictable repayment schedule. The actual fees and terms matter in both cases.

Start with when your business needs the money

Imagine you run a company that sells goods to other businesses. You have to pay a supplier this week, but your customer will pay you in 45 days. Your company has made a sale, yet the payment has not arrived. You need enough money to pay the supplier while you wait.

That is a cash-flow gap. Cash flow is the money coming into and leaving your business. Even a company with healthy sales can have a cash-flow gap when bills are due before customers pay.

Now imagine the same company wants to invest $150,000 in a major expansion. It knows the full cost of the project and expects the expansion to help the business over the next few years. That is a different borrowing need.

The first question is therefore simple: Will you need the money for a short period, from time to time, or all at once for a planned expense? The answer is a useful starting point, although it does not determine what a lender will offer.

How does a business line of credit work?

A business line of credit gives a business an approved borrowing limit. If the limit is $150,000, that tells you the most the business may be allowed to borrow under the agreement. It does not mean the business has already received or spent $150,000.

Using money from the line is often called a draw. If you draw $60,000, that amount becomes your outstanding balance, which means the amount you still owe. With a revolving line of credit, paying down that balance can make room to borrow again, as long as the account remains open and the lender's conditions are met.

For many lines of credit, interest is charged on the money actually borrowed. But a lender may also charge setup fees, fees for taking money out, account fees or renewal fees. Some products have regular principal payments, while others have different payment rules. A line may also be reviewed, reduced, or repayable on demand under its agreement. You need to check how the specific offer works before relying on that borrowing limit. ^[1][2]

A line of credit may be worth exploring if your company regularly pays expenses before collecting customer payments, has seasonal changes in sales, or needs access to funds at several different points during the year.

How does a business term loan work?

A business term loan generally provides a set amount of money under a repayment agreement. For example, a business might receive $150,000 to pay for a planned project and repay it over three years.

Each payment usually includes some principal, which is the money borrowed, and interest, which is a charge for borrowing. The exact payment schedule depends on the agreement. Some loans have fixed rates, while others have variable rates that may change. Payments may be required monthly or more often. Fees and rules about paying the loan back early can also change the total cost. ^[3]

A term loan can make planning easier when you know the amount needed and when you expect to be able to make the payments. But receiving the full amount upfront may mean paying interest on money before you have a use for it. You also need enough cash coming into the business to keep up with payments while a project is getting started.

Two examples show why timing matters

These examples use made-up interest rates to explain the math. They are not BGC rates, lender quotes or typical offers, and they leave out fees. Because the examples fund different needs over different periods, comparing their interest totals would not tell you which option is cheaper.

Example 1: A $60,000 expense while a customer payment is pending

A distributor has an approved line of up to $150,000, but it only needs $60,000 to pay suppliers today. Its customer is expected to pay in 45 days.

Suppose, for this example only, that the line charges 12% simple interest per year, calculated on the amount used, using a 365-day year. There are no other fees in this example.

The estimated interest on that $60,000 for 45 days would be:

$60,000 × 12% × 45 ÷ 365 = $887.67

If the customer pays as expected and the distributor repays the balance after 45 days, the short borrowing period limits how much interest builds up under these assumptions. Real lines may calculate interest differently, charge fees or require payments before the customer pays.

The most important question is what happens if the customer takes 75 days to pay instead of 45. The distributor needs to know whether it can manage the extra cost and any payments due along the way.

Example 2: A $150,000 project paid for upfront

The distributor also plans an expansion that requires $150,000 at the start. It expects the project to support the business for several years.

Suppose it receives a $150,000 term loan at a hypothetical fixed 12% nominal annual interest rate, paid back over 36 months in equal monthly payments. Assume interest is calculated monthly and there are no additional fees.

Under these assumptions, the payment is approximately $4,982.15 each month. Across 36 payments, the total interest would be approximately $29,357.27, before any fees. Minor differences in rounded payment amounts can change the final few cents.

A payment schedule gives the business something concrete to plan around. It must still ask whether the expansion will bring in enough money, soon enough, to make those payments comfortably.

The key lesson: The first example covers a smaller amount for 45 days. The second funds a much larger expense over three years. Their interest totals are different because the borrowing needs are different. To decide between actual offers, compare financing for the same expense and repayment period whenever possible.

What should you compare before accepting an offer?

A lender may offer a line of credit, a term loan, or another structure. Before choosing, write down exactly what the business will receive, when it can use the money and what it must pay back.

Look carefully at these points:

• Money available: Is the full amount advanced now, or is it a credit limit you draw from as needed?
• Payments: How much is due each week or month, and when does the first payment start?
• Total cost: How much will the business repay in total if it follows the agreement, including interest and all fees?
• Unused funds: Are there fees for keeping a line open even when you have not drawn money?
• Rate changes: Can the interest rate change, and what would that mean for the payments?
• Borrowing again: Can the business reuse amounts it repays, or would it need a new application?
• Security and guarantees: Does the lender require assets as security or a personal guarantee? A guarantee can make a person responsible if the business cannot pay.
• Early repayment and renewal: Can the business repay early without extra cost? Can the lender review, reduce, demand repayment of, or decline to renew the financing?

Two offers with the same advertised rate can still cost different amounts once fees, payment dates and borrowing periods are included. Where a lender shows an annual percentage rate or another cost measure, check what is included before relying on it to compare offers.

Which option fits different business situations?

A line of credit may suit a retailer that buys stock throughout the year, or a service business that must cover payroll while customers take time to pay. The business needs money at different times and expects to repay some of it when customer payments arrive.

A term loan may suit a company with one planned project that has a known budget. The business can match a payment schedule to the money it expects the project to bring in. The loan terms still need to fit the company's actual cash flow.

Sometimes a business has both needs. It may want financing for one long-term project and access to a smaller amount for regular cash gaps. That does not mean every business should take both products. The added payments, fees and lender requirements must make sense together.

Be careful about using a line of credit for an expense that will take years to pay off. If the line is reviewed or reduced before the project starts producing money, the company may face a serious shortage. It is also worth looking closely at a term loan whose payments start well before a project brings in revenue. ^[1]

What will lenders look at?

Lenders need to understand whether the business is likely to repay the financing under the proposed schedule. Depending on the lender and product, they may look at sales, money left after expenses, how long the business has operated, existing debts, credit history and the reason for borrowing. Some may also ask for financial statements or recent business-bank records.

These are possible review factors, not one set of minimum rules for all lenders. Our guide to business financing eligibility explains what information can help you prepare.

Better Growth Capital reviews financing requests and may share a completed application with selected funding partners. BGC does not itself pull credit bureau reports. A funding partner may contact you and may request permission to check credit as part of its own review.

How to take the next step

Before you apply, write down four things: the amount you need, when you'll need it, when you expect customers to pay you, and the payment your business could afford. This gives you a stronger starting point than choosing a financing product by name alone.

Better Growth Capital is a Canadian business financing broker. We help businesses explore financing options through third-party lenders and funding partners. The available structure, cost and approval depend on the business and the provider reviewing the request.

You can explore our business line of credit and business term loan pages, or apply for business financing when you're ready to have your request reviewed.