Comparing Lines of Credit to Other Types of Borrowing

When you need funding for your business, finding the right lender is vital. But more importantly, you need to ensure you are choosing the right kind of loan. Business funding is not one-size-fits-all, and what works for one business might not be the best choice for another. As you compare various loans and lines of credit, here are comparisons that can help you find your ideal funding match. First of all, let us look at lines of credit

What is a line of credit?

A business line of credit and credit card are alike in that the lender approves you for a particular credit limit, and you withdraw the cash as you need it and make payments only on the amount you have withdrawn. Lines of credit are an excellent choice for business owners who require cash now and might require quick access to more in the future since you will have continual access to credit as far as you pay down your balance.

Like most small business loans, lines of credit are available from a variety of banks and lenders. The Small Business Administration also has a business line of credit program, known as CAPLines, available for specific uses: seasonal activities, contracts, short-term working capital, and construction projects.

Lines of credit loan structure and repayment

Lines of credit work differently. Akin to a credit card, the lending institution sets a credit limit. You can borrow up to that limit for a predetermined length of time, known as draw period. During the draw period, you will make interest payments and principal on the amount you have borrowed.  After the draw duration ends, you will have a certain period to repay the outstanding balance. Though the best part is that you can keep on borrowing up to your limit as far as you pay off the balance, indicating you can reuse that credit line over and over again to suit your needs. This offers a business with more long-term flexibility than compared to a loan.

Lines of credit vs. term loans

Term loans and lines of credit are popular business funding options. A business term loan might be a good option if you have a specific project in mind: buying a new piece of equipment, or expanding to a new location, or purchasing out a competitor. Generally, a line of credit could be best if you have a tendency to find yourself short of working capital, and you require help managing unsteady cash flow. Being able to tap your credit line can help you quickly ramp up before a busy season begins, or cover your bills through a slow season. Some financial institutions provide both of these options, so speak to your banker to understand the benefit of each. Business credit cards can also aid with short-term funding; however, a line of credit might have lower interest and can be a better option if you need more than a few weeks to pay off the purchases. Some vendors also do not accept credit cards or will charge you a fee to use one.

Unsecured vs. secured loans and credit lines

You can find both unsecured and secured options for business and personal funding. An unsecured loan means a creditor is providing you money based on your promise to repay the loan with no collateral. Falling behind on unsecured loan payments can make you hurt your credit score.  Besides, the creditor can also sue you or the company and might be able to take money from your paychecks, take money, or freeze your bank accounts and get judgment liens against your business or personal property.

An unsecured loan might have a higher interest rate since there is more risk to the lender. On the contrary, secured loans require collateral, which is something of value that the creditor can take if you do not repay the debt, such as property or equipment. But even with collateral, falling behind can result in fees and hurt your credit, and the creditor can still file a lawsuit provided the collateral’s value does not cover the balance.

Mortgages or auto loans are examples of secured loans. Likewise, business loans that are taken out to buy a particular piece of equipment- fittingly known as equipment funding- might be secured by that equipment. Generally, secured business loans might require a blanket lien, providing the creditor the right to the business’s assets, equipment, inventory, and accounts receivable if the business does not repay the loan.

Unsecured loans are not as risky to you since you will not lose physical assets if you can not repay the loan. Nonetheless, since secured loans are safer for creditors, you may be able to get lower interest rates with a secured loan.

SBA loans versus lines of credit

The United States Business Administration partially backs loans that range from $5,000 up to $5 million to assist small businesses, even though commercial banks and online lenders actually offer the loans. The government support makes APR rates lower since lending institutions have greater confidence that they get their money back. SBA loans can be utilized for almost any business purpose and have long repayment terms and low APR rates, but the application process is long and time-consuming.

There are various types of SBA loans. Microloans lend up to $50,000 to new businesses, whereas SBA 7(a) loans cover several business purposes, and the CDC/504 loans are best for buying major assets such as large equipment or real estate.

Generally, SBA loans are best for established businesses with strong financials who require funding for various purposes. In contrast, business lines of credit are suitable for business owners who need a flexible form of funding to cover more immediate funding needs.

Business vs. personal loans and credit lines

Most small business owners initially fund their business with personal loans or lines of credit. Once you apply for a line of credit or a personal loan (like online or a bank lender) will solely check your personal finances to evaluate if you are approved and your terms and rates.

Your personal debt-to-income ratio, credit history, credit score, and other outstanding debts can all come into play. In turn, taking on the loan can also affect your ability to qualify for more personal financing in the future- even though you do not plan on using the funds for your business. Moreover, you will personally be responsible for all the debt.

A business loan or business line of credit is lent with the particular purpose of assisting a business. As an entrepreneur, your personal creditworthiness might be a factor in getting approved. However, creditors will also consider the business’s credit reports, bank statements, credit scores, and overall finances. Some business lenders might require a minimum revenue threshold or only provide loans to established businesses. And based on your business history and size, you might need to sign a personal guarantee for a business loan or credit line.

With a personal guarantee, you will be legally accountable for the debt if the business can not afford to repay the loan. Even so, you might find it simpler to get accepted for higher loan amounts or credit limits, and keeping your money separate can be a good idea despite the personal guarantee. Even though it is not always an option when you are just beginning, using personal funding for personal purposes and business funding for business purposes is often a good approach.

Home equity line of credit vs. equity loan

Home equity loans (HELs) and (HELOCs) and home equity lines of credit are personal debts that are secured by your home equity via a credit union or bank. For the majority of people, their home is their most valuable asset, and one of the few things they can utilize as collateral to qualify for a huge loan.

Nonetheless, you are also putting your home at risk since your creditor could foreclose on the property if you can not afford the HELOC or HEL loan payments anymore. The procedure can also take time and be comprehensive since you might need to get your home appraised to take out a HELOC or HEL. When it comes to the difference between the Home line and Home equity line: While the home line is fixed, home equity is variable. The other features are similar; for instance, you might qualify for a larger loan with reasonable terms for both loans. Also, both loans often have a fixed interest rate and fixed payments.

Typical terms  Home Equity Line of Credit Home equity loan
  • Fixed monthly payments during repayment duration
  • Interest-only payments during draw period
Fixed monthly payments
Loan terms ten year draw period followed repayment duration 5 to 30 years
APRs 3.5 – 6.7 (percent) 3.2 – 7.5 (percent)
Interest rates Variable  fixed
Major fees
  • One-time origination charge: 0% – 1% of loan amount
  • Prepayment penalty ranging from 0% – 1% of loan amount
  • Closing charges: $0 – $250
  • One-time application charge: $8 – $20
  • Ongoing annual charge: $50 – $75
  • Prepayment penalty ranging from $0 – $500
  • Closing charges: $0 – $450
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