If you are an entrepreneur and seeking capital to smoothly run or expand your business, it would be quite beneficial for you to be aware of the available options. Financial institutions offer different types of business loans - line of credit and term loan being the most preferred ones. While they both can take care of your financial needs, they are quite different from one another in terms of the features, terms, and conditions. So, before you choose the loan that suits your business interests the best, let us discuss how the two lending options are different from each other.
What is Line of Credit?
Line of Credit (LOC) is an agreement between financial establishments and customers that establishes the maximum amount of loan that can be borrowed by the customer. This fixed amount enables the customer to borrow money (within the sanctioned limit) for diverse reasons in return for a timely minimum payment.
So how does Line of Credit work? All the LOCs have a definite amount of money that the customer can use, repay, and use again. The rate of interest depends on the loan amount and the tenure.
Features of LOC
- LOC enables a customer to access the loan amount as long as s/he adheres to the sanctioned limit.
- The borrower can break up the amount in chunks and take the money as per requirement. It is not an absolute necessity to take the entire capital.
- The feature of borrowing and instantly repaying is perhaps the best option as it keeps the debt and recurring charges at bay.
- Once the borrower withdraws a certain amount of capital, the limit comes down from the total amount, which reduces the credit limit automatically. It can be refuelled upon repayment.
- You pay the interest only on the amount that you borrow and not the entire capital.
- The interest rate in Line of Credit ranges between 10 per cent – 15 per cent depending upon the creditworthiness of the borrower.
Types of LOC
There are two types of LOC under the security parameter - Secured LOC and Unsecured LOC. A collateral backs the secured LOC, which can be in the form of property mortgage, life insurance policies, fixed deposits or other liquid assets. In the case of unsecured LOC, the loan is not backed by any collateral and mainly relies on the credit history of the borrower and repaying capacity upon which the amount is sanctioned.
2. Facility LOCs:
Facility LOCs are of two kinds - Personal LOC and Business LOC. The difference lies in the utility of these sanctioned amounts. It can be either for business or for some personal use.
What is a Term Loan?
A Term Loan is the specific amount granted backed by a proper repayment schedule with a fixed or floating rate of interest. It is often availed by businesses with a good repayment history and sound business operations. It may or may not require a down payment, which will eventually be debited from the capital amount.
How does a term loan work? Usually, business owners who are looking for a lump sum financial backing or for their monthly operation consider taking a term loan. Financial institutions offer this amount for a fixed duration to help the borrowers out with their requirements.
Features of Term Loan
- These are secure loans lent only to the company and not the owners or specific individuals.
- These loans come with repayments attached with the rate of interests.
- They can be secured or unsecured.
- They are less risky for financial institutions.
Types of Term Loans
1. Short Term Loan:
Offered to businesses that do not have a huge capital requirement and are given the required amount for a tenure of 18 months or less.
2. Intermediate Term Loan:
Has a tenure for more than one but less than three years and is paid back in instalments with the decided rate of interest.
3. Long Term Loan:
This type of loan goes on for about 3 to 25 years and requires collaterals like land mortgage, large machineries or quarterly payments from profits or cash. Such loan also inhibits the company from taking other forms of debts.
Line of Credit Vs. Term Loan - Which is better for your business?
Term Loans are perfect for business expansion or some investment, which requires huge and long-term capital. Line of Credit is suitable for working capital requirements of any business where they frequently need funds to meet day-to-day business expenses. It totally depends on the business requirement if you need it for capital then Term loan makes more sense, on the other hand, Line of Credit is best for Working capital needs.
To summarise, LOC is a fixed amount that financial institutions decide and offer a customer based on his/her requirements, repayment history, and credibility. Term Loan is capital assistance offered to businesses, which is usually granted against a guarantee in the form of mortgage or other assets. If you are looking for small-term capital, LOC is your best bet while long-term financial reinforcement calls for Term Loans.