The difference between business loans and lines of credit

What is a business loan?

A business loan is typically a lump sum of money provided by a lender to a borrower. The lump sum is commonly subject to interest charges or up-front fees and are repaid over time. A business owner can apply for a business loan to cover large or long-term expenses, such as equipment or real estate purchases.

How does a business loan work?

Lenders will usually set their own terms for each business loan based on a borrower’s application, credit history, and financial standing. A borrower with a strong credit score, for example, may receive a lower interest rate for their loan.

Business loans are typically repaid in monthly installments over a set period of time, such as several months or years. They may come with fixed interest rates or fees, which remain steady over the lifetime of the loan, or variable interest rates, which can fluctuate.

Potential pros and cons of business loans

Some of the most notable advantages of business loans may include:

• Predictable payments. Pay back funds in set, predictable installments over time.
• Large loan amounts. Borrow large amounts of money to pay for hefty expenses, such as launching new products, funding an ad campaign, or hiring additional staff.

Still, business owners should be aware of potential challenges, such as:

• Lengthy application processes. Borrowers may need to provide detailed documentation and collateral to receive a business loan.
• Strict credit requirements. Traditional lenders may require a certain credit score or strong credit history for approval.

What is a business line of credit?

A business line of credit is a type of financing that lets borrowers withdraw money as they need it, similar to a credit card. Once you pay off your balance, the funds are replenished. So you can continue spending as long as you don’t exceed your credit limit.

How does a business line of credit work?

Business owners can generally use a line of credit to withdraw cash for any type of business expense or purchase for the business. They then pay off their outstanding balance plus any interest or fees each month.

Potential pros and cons of business lines of credit

There may be benefits to opening a business line of credit, such as:

• Flexibility. Draw funds as needed and only pay interest or fees on what you borrow.
• Improved cash flow. Have a revolving pool of cash on hand to cover unexpected or seasonal changes in cash flow.

However, the potential drawbacks to lines of credit may include:

• High interest rates. Business lines of credit may come with high and more variable interest rates or fees compared to business loans.
• Unpredictable payments. Monthly payments can change based on how much you borrow and fluctuations in your interest rate or fees.

Business line of credit vs. business loan

It’s important to compare and contrast a business loan vs. a line of credit. There are key differences between these two business financing options, including:

• Borrowing amounts. Business loans may be for higher amounts and are repaid over longer periods. However, lines of credit provide the flexibility to access funds as you need them.
• Interest rates. Business loans often come with lower interest rates or fees than lines of credit.
• Payments. Business loan payments may be steady and predictable while line of credit payments often change over time.

How to choose which business financing option is better for you

When choosing between a business line of credit vs. loan, you should assess your individual business needs, financial goals, and risk tolerance. It’s also important to research options and speak to a trusted advisor.

As you get started, you can ask yourself these questions to help make an informed decision and determine the right choice for your specific situation:

• Am I seeking funding for short-term or long-term expenses?
• Do I know how much money I need upfront? Or do I want the flexibility to withdraw funds over time?
• How long will I need to pay back my loan?
• Do I want a fixed or variable interest rate? How much interest am I able and willing to pay?
• Do I want to make fixed and predictable payments or fluctuating payments based on how much I borrow?
• Will I want the option and flexibility to pay off my loan early?

Where to apply for business loans and lines of credit

In general, many banks, credit unions, and traditional financial institutions offer loans and lines of credit to businesses. You may also be able to apply through an online lender or lending marketplace.

Each lender has its own application process. To be approved, you may need to provide important information, such as financial statements and tax returns, as well as your credit score and business license.

Learn more about how to apply for a PayPal business loan.

Alternative financing options

Entrepreneurs can consider other business financing options outside of loans and lines of credit. Here are some examples:

• Business debit or credit cards. Separate your personal card accounts from your business accounts and potentially earn rewards for certain purchases.
• Merchant cash advances. Receive a lump sum of money and pay it back using a percentage of your daily or weekly sales.
• Crowdfunding. Gather donations from supporters and community members.
• Peer-to-peer lending. Use peer-to-peer lending apps to borrow money directly from investors.

As with business loans and lines of credit, each of these alternative financing options come with their own pros and cons. You should carefully evaluate any financing options before moving forward, and consider consulting trusted advisors when making a decision.

Find the right financing solution for your business

You may need access to funding as you take on new expenses, acquire assets, and expand your inventory. Business loans and lines of credits may be two solutions you can explore to help finance growth.

Learn more about how to fund and grow your business with PayPal.