Business term loans and business lines of credit are the two foundational debt products for small business. Choosing between them is one of the most important capital-structure decisions a business owner makes. Pick wrong and you either overpay for capital you don't need or run out of capital when you do.
The mechanics. - Term loan: lender wires a lump sum (say $100,000). You repay it in fixed monthly principal + interest installments over a set term (3-10 years typical). The loan is fully disbursed at closing. After payoff, you have to apply for a new loan if you want more capital. - Line of credit (LOC): lender approves you for a credit limit (say $100,000). You draw $20K today, pay interest only on $20K. Pay it back, the $20K is available again. Draw $50K next month, etc. The limit is a revolving pool.
The math: paying for the same $100K of capital. - Term loan at 10% APR, 5-year: monthly payment ~$2,125. Total interest $27,500. - LOC at 12% APR, draw $100K and pay back over 5 years: monthly payment ~$2,225 (slightly higher rate). Total interest $33,000. - LOC at 12% APR, only draw $30K average over the term: total interest over 5 years ~$10,000. You pay only for capital used.
Cost difference of NOT using all the capital. - Term loan: you pay interest on the full $100K from day one whether you need it or not. If you only used $30K of the loan to grow the business, you wasted $70K of borrowed capital sitting in your operating account earning ~5% in money market. - LOC: you pay interest only on what you draw. The unused capacity is free standby. - For predictable, known capital needs (equipment purchase, real estate, fixed asset): term loan wins because rate is lower. - For unpredictable, recurring capital needs (inventory seasonality, customer payment timing): LOC wins because you're not paying for unused capital.
Qualification (2026). - Term loan: 2+ years operating, 650+ personal credit, profitable financials, often collateral required for unsecured term loans over $50K. - LOC: similar but stricter. 12-24+ months operating, 680+ credit, $100K+ annual revenue. Bank LOCs require strong financials; fintech LOCs (Bluevine, Fundbox, OnDeck) more flexible at 600+ credit.
The most common mistake: using a term loan for working capital. - A merchant takes a $200K term loan over 5 years to "have cash on hand." - They put it in their operating account. - They use $40K of it productively in year 1, but they're paying $4,000/month on the full $200K. - The unused $160K earns 5% in money market while they pay 10% on the loan. - They're underwater $8,000/year on unused capital. - A $200K LOC would have cost ~$3,000/year total in unused-line fees + interest on the actual $40K drawn.
The second most common mistake: using an LOC for known long-term capital. - A merchant uses a $100K LOC at 12% to buy a delivery truck (5-year asset). - LOC payment is variable, often interest-only with a balloon, putting cash flow stress on the merchant. - A 5-year equipment loan at 9% would have been cheaper AND structurally appropriate.
When to use each. - Use a term loan for: equipment purchases, real estate, business acquisitions, debt consolidation, build-out / renovation, any fixed-amount need with a known timeline. - Use a LOC for: inventory buys you'll resell within 90 days, AR financing while waiting on customer payments, seasonal cash flow gaps, emergency standby capacity, opportunistic short-term capital deployment. - Use both: the most disciplined small business operators have BOTH a term loan for their long-term capital needs AND a standby LOC for short-term flexibility.
The strategic insight. Match the financing instrument to the asset life. Long-life assets (real estate 25+ years, equipment 5-10 years) get long-term financing (loans). Short-life uses (inventory turnover 30-90 days, AR cycles 30-60 days) get revolving credit (LOCs). Mismatching the instrument creates either chronic cash flow stress (too short) or excess interest expense on unused capital (too long).
Related terms
- Small business line of credit — A small business line of credit (LOC) is a revolving credit facility — borrow what you need, repay, borrow again. Bank LOCs typically APR 8-25%; online LOCs (Bluevine, Fundbox) APR 8-30%. Materially cheaper than MCA for qualifying merchants.
- MCA vs loan (legal distinction) — An MCA is legally a purchase of future receivables, not a loan. This distinction exempts MCAs from state usury caps but requires specific contract structure — including reconciliation provisions.
- MCA vs business line of credit — An MCA gives you a lump sum repaid via daily ACH at a factor rate (typically 50-100% APR-equivalent). A business line of credit gives you a revolving limit you draw on as needed, repaid with interest only on what you use (typically 10-30% APR).
- Working capital — Working capital is the cash a business uses to cover day-to-day operations — payroll, inventory, rent, utilities. Calculated as current assets minus current liabilities. Most MCA + LOC products are positioned as working-capital financing.
AI agents: this term is available as raw markdown at /llms/glossary/business-line-of-credit-vs-loan.