Business loans and business lines of credit are often confused, but they are actually two very different types of financing.
Understanding the differences between a loan and a business line of credit can help business owners choose the type of financing that best suits their financial needs.
What Is the Difference Between a Business Loan and a Business Line of Credit?
The main difference between a loan and a business line of credit is flexibility. Loans are generally more rigid and require precise repayment according to the terms of the loan, while lines of credit offer greater flexibility by allowing the company to borrow funds according to its needs. Business lines of credit are often used to cover day-to-day operating expenses such as salaries, supply bills and overhead.
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Business Loan
A business loan is a sum of money that the borrower receives from a lender and must be repaid with interest. Loans can be short or long term, and repayment terms can vary depending on the type of loan and the lender. Loans can be secured or unsecured, which means the borrower may have to post collateral or a collateral asset to obtain the loan.
Example of repayment of a business loan: Suppose the business got a $20,000 loan with an annual interest rate of 10% and a repayment term of 2 years (24 months). In this case, the monthly repayment amount would be $947.22 per month for 2 years. This amount includes part of the interest and part of the repayment of the capital. Over time, the interest portion of the monthly repayment will decrease while the principal repayment portion will increase, until the total debt is paid off in 24 months.
Business Line of Credit
A business line of credit, is an agreement between a business and a financial institution that allows the business to borrow money based on its financial needs. The line of credit is usually renewed as the business repays the funds it has borrowed. Interest rates for a business line of credit can vary depending on the line of credit usage and business credit.
Example of repayment of a line of credit: Assume the business has access to a $20,000 line of credit with an annual interest rate of 10%. Over time, the company decides to use only $10,000 of this pool of funds to finance its business expenses. The minimum monthly repayment for a line of credit can be calculated by dividing the annual interest rate by 12, then multiplying it by the amount used, which is $10,000. In this case, the monthly interest rate would be 10% / 12 = 0.83%. The minimum redemption amount would therefore be 0.83% x $10,000 = $83.33.
Bottom Line
Business loans and business lines of credit are two different financing options that can help business owners finance their operations. Loans are often used to fund longer-term projects such as capital investments, while business lines of credit are used to cover day-to-day operating expenses.
Business owners should consider their current and future financial needs as well as their ability to repay before choosing between a business loan or line of credit.
It is important to do thorough research and compare different offers to choose the type of financing that is best for their business.
