Term Loan vs Line of Credit: Definition, Types, Features & Comparison

If you are an entrepreneur seeking capital to operate or expand your business, understanding your financing options is critical for maintaining healthy cash flow. Regulated NBFCs and banks offer diverse credit products, term loan vs line of credit being the two most prominent instruments for MSMEs. Under the latest RBI Digital Lending Directions, lenders must now provide a Key Fact Statement (KFS) for both, detailing the Annual Percentage Rate (APR) to ensure transparency. While both provide liquidity, they differ significantly in structure, interest accrual, and repayment.

What is a Line of Credit?

A Line of Credit (LOC), or line of credit loans, is a flexible arrangement between a financial institution and a borrower. As of this year, many NBFCs offer "Digital LOCs" with instant withdrawal features. It establishes a maximum sanctioned limit from which you can draw funds as needed.

Features of a Line of Credit

• Revolving Nature: You can borrow, repay, and borrow again within the limit. This functions similarly to a business credit card but often at lower interest rates.
• Interest on Utilization: You pay interest only on the amount withdrawn, not the total limit.
• Flexible Drawdowns: You can take the money in small "chunks" rather than a lump sum.
• Automatic Limit Restoration: Upon repayment, your available credit limit is refuelled instantly.
• Dynamic Pricing: The interest rate for a line of credit typically ranges from 10.75% to 18% p.a., depending on the business’s credit history and cash flow.

Types of Line of Credit

1. Secured vs. Unsecured LOC: Secured lines require collateral (property, FDs), while unsecured lines rely on your CIBIL score and business vintage.
2. Personal vs. Business LOC: Business LOCs are specifically designed for operational liquidity and offer higher limits than personal credit lines.

What is a Term Loan?

The term loans are traditional credit products where a specific lump sum is disbursed upfront. These are the preferred choice for major capital expenditures (CAPEX) due to their structured repayment nature.

Features of a Term Loan

• Lump Sum Disbursement: The entire sanctioned amount is credited to your business account at once.
• Fixed Repayment Schedule: Repayments are made via Equated Monthly Installments (EMIs) over a fixed tenure.
• Interest on Full Amount: Interest is charged on the entire disbursed amount from day one.
• Predictability: Fixed or floating rates allow for long-term financial planning. Average interest rates for business term loans in 2026 start from 10% p.a. at major NBFCs.

Types of Term Loans

1. Short-Term Loans: Tenure of up to 18 months; ideal for temporary cash gaps.
2. Intermediate-Term Loans: Tenure between 1 to 3 years.
3. Long-Term Loans: Tenure ranging from 3 to 25 years; usually requires collateral like heavy machinery or real estate.

Line of Credit vs Term Loan: Detailed Comparison

Deciding between a line of credit vs term loan depends on your specific use case. Term loans are best for asset creation (e.g., buying a factory), while a line of credit is superior for working capital (e.g., managing seasonal inventory).

Strategic Choice: Which is Better for Your Business?

If your business needs ₹50 Lakh for a new production line, a term loan provides the structure you need. However, if you face unpredictable cash flow gaps due to delayed client payments, a line of credit offers the agility to meet daily expenses without over-borrowing.

At Hero FinCorp, a regulated NBFC, we offer both products tailored to MSME loan needs. All our digital loans now come with a standardized Key Fact Statement (KFS) as per the RBI mandate, ensuring no hidden costs.

Frequently Asked Questions (FAQs)

Can I Use A Line Of Credit For Loan Repayment?

Under RBI’s Fair Practices Code, businesses should use credit for intended purposes. While you can technically use LOC funds for liquidity, utilizing one loan to pay another ("Evergreening") is discouraged by regulators.

Are There Foreclosure Charges For These Loans?

For micro and small enterprises (MSEs), RBI often mandates nil foreclosure charges on floating-rate loans. For others, charges typically range from 2% to 4% of the outstanding principal.

What Is The "Cooling-Off Period" In Loans?

As per the RBI Digital Lending Directions, borrowers have a minimum 1-day cooling-off period to exit the loan without penalty (though processing fees may be retained).

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