Term loan vs line of credit

Term loans and lines of credit both provide capital, but they are structured for opposite kinds of need. Confusing them is how businesses end up paying interest on money they are not using, or scrambling for a lump sum when what they needed was flexible access.

A term loan hands you a single lump sum up front, which you repay in fixed installments over a set period, anywhere from a year to several years. Interest accrues on the full amount from day one, whether or not you have spent it. Rates can be fixed or variable, and the payment is predictable, which makes budgeting simple.

Term loans fit one-time, known costs: buying equipment, funding a build-out, an acquisition, or consolidating other debt. You know the number, you borrow it once, and you pay it down.

A line of credit is revolving. The lender approves a maximum limit, and you draw against it as needed, pay interest only on what you have actually drawn, and the available balance replenishes as you repay. It behaves like a credit card without the card.

Lines fit recurring or unpredictable needs: covering payroll during a slow month, bridging the gap between invoicing and getting paid, or buying inventory ahead of a busy season. You are paying for flexibility and access, not for a fixed pile of cash.

On a term loan you pay interest on the whole balance for the whole term, so if you only need money occasionally, you are overpaying. On a line you pay only for what you use, but lines often carry draw fees, annual or maintenance fees, and variable rates that can rise. Lines can also be secured or unsecured, and secured lines usually carry lower rates.

Term loans usually offer larger amounts and longer horizons; lines are typically smaller and meant to be paid down and reused rather than carried at the max indefinitely. A line also comes up for periodic review and renewal, and a lender can cut or freeze it if your financials weaken, so it is access on the lender terms, not a guarantee.

Say you need $60,000 to buy a piece of equipment. A term loan is the clean fit: you take the $60,000 once and pay a fixed amount every month until it is gone. Now say instead that your revenue lands unevenly, and some months you are $15,000 short on payroll before customer payments arrive. A $60,000 line fits that far better, because you draw the $15,000 when you are short, repay it when the receivables land, and pay interest only on the weeks you actually owed it.

Run the same limit through both and the difference is stark. On the term loan you pay interest on the full balance the entire term. On the line you might carry a balance only a third of the year, so even at a similar rate you pay a fraction of the interest, in exchange for a limit you have to qualify for and keep in good standing.

Ask one question: is this a single known expense or an ongoing, variable need? A known expense wants a term loan. A recurring cash-flow gap wants a line. Many established businesses keep a line open as a standing cushion and take term loans only for specific projects, so the two are complements more than competitors.

If you can qualify for both, a common setup is to keep a modest line open for timing and emergencies and reach for a term loan only when a specific, sized project justifies borrowing a fixed sum. That way you are never paying interest on idle cash, and you are never caught without access when a slow month hits.