Business Line of Credit vs. Term Loan: How to Pick the Right Tool

If you put both in front of a small business owner, a $100,000 line of credit and a $100,000 term loan look identical. The difference shows up in how — and when — you actually use the money.

What you’re paying for, in each case

A term loan is a lump sum delivered on day one. You start paying interest on the full balance immediately, on a fixed monthly schedule, until it’s paid off.

A line of credit is a credit limit you can draw against whenever you want, up to that limit. You only pay interest on what you’ve actually drawn. As you pay it back, the available balance refills.

That difference — interest on what you’ve borrowed vs. interest on the full amount — is the entire game.

The math that matters

Imagine you need $100K to handle a slow Q1, but you’ll only end up using about $40K of it.

• Term loan at 12% APR over 3 years: You pay interest on the full $100K from day one. Total interest paid over the term: roughly $19,500.
• Line of credit at 14% APR, $40K average balance for one year, then paid off: You pay interest on $40K for 12 months. Total interest: roughly $5,600.

Even though the line has a higher rate, you pay a third of the interest because you’re not paying for money you didn’t need.

When a term loan wins

• You know exactly how much you need and what for. Buying a piece of equipment. Funding a buildout. Paying off other debt.
• The use is one-time, not recurring.
• You want a predictable monthly payment for budgeting.
• You’re financing a long-life asset (real estate, machinery) and want to match the loan term to the asset’s useful life.

When a line of credit wins

• Cash flow is uneven and you need a buffer.
• You bid on projects and need short-term capital between billing and collecting.
• You don’t actually know yet what the next 12 months will require.
• You want to keep dry powder for an opportunity you can’t predict.

The hybrid approach most successful operators use

Many businesses we work with end up with both: a term loan for the big one-time things (equipment, expansion, real estate) and a line of credit for the day-to-day. The line is the safety net; the term loan is the deliberate move.

Lenders are fine with that combination — they actually prefer it, because it shows financial sophistication.

How to decide right now

Ask yourself one question: “Do I know exactly how much I need and what I’ll spend it on?”

• Yes → term loan.
• No → line of credit.

If you’re 80% sure on the number and 100% sure on the use, term loan. If you’re 50/50 on either, line of credit, every time.