Term Loan vs. Line of Credit: Which Is Better for Your Small Business?

When small business owners think about financing, two options come up again and again: the term loan and the business line of credit. Both can help your business, but they work differently and are better suited to different situations.

Understanding the difference between a term loan and a line of credit can help you choose the option that fits the way your business actually uses money – instead of just picking whatever you’re offered first.

What Is a Term Loan?

A term loan is what most people think of as a “regular” loan. You borrow a set amount of money and repay it over a fixed period of time, with interest.

Key features of a term loan

• Lump sum: You receive the full loan amount up front.
• Fixed repayment schedule: You make regular payments (often monthly) over a set term.
• Predictable payments: Many term loans have fixed payments that stay the same each period.
• Used for larger, one-time needs: Such as renovations, expansion, buying equipment, or consolidating debt.

A term loan can be a good fit when you know exactly how much you need and you’re making a clear, one-time investment in your business.

What Is a Business Line of Credit?

A business line of credit works more like a credit card for your business. You’re approved for a maximum limit, and you can draw from that limit, pay it back, and use it again, as needed.

Key features of a line of credit

• Flexible access: You can draw funds when you need them, up to your limit.
• Revolving: As you pay down what you’ve borrowed, those funds become available again.
• Interest on what you use: You typically only pay interest on the amount you actually borrow, not the entire limit.
• Used for ongoing or seasonal needs: Such as managing cash flow, covering short-term gaps, or handling small, recurring expenses.

A line of credit can be a good fit when your needs are more flexible and you don’t know exactly when or how often you’ll need access to funds.

Term Loan vs. Line of Credit: How They Compare

1. How you receive the money

• Term loan: You get one lump sum up front.
• Line of credit: You draw what you need, when you need it, up to your limit.

2. How you repay the money

• Term loan: Regular payments (often monthly) over a fixed term.
• Line of credit: More flexible payments; you may have interest-only payments for a period, or minimum payments based on what you’ve borrowed.

3. Predictability of payments

• Term loan: Generally more predictable; you know your payment amount and schedule.
• Line of credit: Payments can vary depending on how much you’ve borrowed and when you draw funds.

4. Best use cases

• Term loan: Larger, one-time projects – renovations, expansion, major equipment, buying a vehicle, or consolidating higher-cost debt.
• Line of credit: Short-term or recurring needs – seasonal inventory, payroll during slow months, or smoothing out cash flow when customers pay at different times.

5. Cost and interest

The cost of either option depends on the lender and your situation, but in general:

• Term loans may have fixed rates and clear total cost over the life of the loan.
• Lines of credit may have variable rates, and the total cost depends on how often and how much you borrow.

Always look at the rate, any fees, and how payments will fit into your monthly cash flow.

When a Term Loan Might Be the Better Choice

A term loan may be a better fit if:

• You have a specific, one-time expense (like a renovation or large equipment purchase).
• You know exactly how much money you need.
• You prefer predictable, fixed payments in your budget.
• You’re comfortable committing to a longer-term repayment schedule.

Term loans can work well when you’re making a clearly defined investment that should generate results over time.

When a Line of Credit Might Be the Better Choice

A line of credit may be a better fit if:

• Your needs are ongoing or unpredictable – like managing seasonal ups and downs.
• You want a backup source of funds for short-term gaps.
• You prefer to only pay interest when you actually borrow.
• You’re disciplined about not maxing out the line and making regular payments.

A line of credit can be especially helpful for businesses that have solid overall revenue but experience timing gaps between when they pay expenses and when customers pay them.

Simple Decision Checklist: Term Loan or Line of Credit?

Ask yourself a few quick questions:

• Is this a one-time project or an ongoing need?
  » One-time project? A term loan may fit better.
  » Ongoing or unpredictable? A line of credit may be more flexible.
• Do I know exactly how much I’ll need?
  » Yes – a term loan can match that amount.
  » Not really – a line of credit can adjust as you go.
• Do I want fixed, predictable payments?
  » Yes – that points toward a term loan.
  » I’m okay with variable payments – a line of credit might work.
• How comfortable am I with using revolving credit?
  » If you’re disciplined with borrowing and repayment, a line of credit can be a powerful tool.
  » If you prefer clear start-and-end dates, a term loan may feel safer.

Can You Have Both a Term Loan and a Line of Credit?

Many businesses eventually use a combination of both. For example:

• A term loan to fund a major expansion or equipment purchase.
• A line of credit to manage short-term working capital and seasonal ups and downs.

The key is to make sure that, together, the payments still fit comfortably within your monthly cash flow.

Final Thoughts: Choose the Tool That Matches the Job

Neither a term loan nor a line of credit is “better” in every situation. The right choice depends on:

• What you need the money for.
• How predictable your expenses are.
• How you prefer to manage cash flow and payments.

When you match the financing tool to the job, you’re more likely to feel in control – instead of feeling like the loan is controlling you.

Important Reminder: Education Only

ChicagoBusinessLoans.com is an educational blog. This article is for general information only and is not personal financial, legal, or tax advice. Every lender has its own requirements and policies. Before you apply for or accept any loan or line of credit, review the terms directly with the lender and consider speaking with qualified professionals who understand your specific situation.