Lines of credits and term loans are powerful tools for addressing a number of distinct financial needs for businesses. First, let’s review what distinguishes the two.
Defining lines of credit and term loans
Term loans
A term loan offers the borrower, in this case your business, a lump-sum payment.
In return, you pay back the amount borrowed, along with interest. You benefit from access to a significant amount of funds on a relatively short timetable, spreading the cost across several months or years.
This type of loan is generally intended for expensive, long-term needs, such as equipment and facilities.
Term loans follow a fixed repayment schedule. This process is called amortization. Once you commit to taking out the loan, you are responsible for paying it back based on the previously agreed-upon timetable.
Term loans may be secured, meaning the borrower has to offer some kind of asset to acquire the funding. These assets are only taken by the lender if the borrower cannot repay the loan. As a benefit, securing a loan leads to lower interest rates.
Term loans are non-revolving, which means they generally can’t be renewed or otherwise reused. You will have to seek out a new loan, if needed.
Lines of credit
A business line of credit offers your company access to funds, although it doesn’t directly disburse them.
Instead, you can draw on your credit to address short-term financial responsibilities as needed. In return, you pay back the amount borrowed and the interest accrued—the same basic requirement as for a loan.
A line of credit revolves, which means that it replenishes as it’s paid off.
While lines of credit are designed for access to short-term working capital—funding upfront costs before a customer makes a payment, for example—they can be used again and again as long as they are paid off in a timely and compliant fashion. It’s important to note that lines of credit generally require a 30-day out-of-debt period before you can once again borrow against them.
Lines of credit are generally secured, meaning they require a form of collateral, in a similar fashion to term loans. This also means lower interest rates for borrowing.
With this foundational knowledge in place, it’s easier to understand the intended purpose of each type of loan.
When to use term loans and lines of credit
Term loans
The specifics of term loans make them a good fit for major business purchases.
They offer a predictable, fixed cost that can easily be included in a business budget. This makes them perfectly suited for addressing larger, more expensive needs.
A term loan presents all costs up front, so that you can accurately plan for:
- Buying equipment.
- Expanding operations into a new region.
- Acquiring new assets and resources.
Lines of credit
A line of credit’s primary purpose for businesses is bridging financial gaps.
Many industries traditionally delay payment from customers for a set period of time. This is a form of trade credit, extended from the seller to the buyer.
For some successful businesses, this delay in payment represents a major pain point. It can delay other actions, like acquiring the resources needed to continue production.
With a line of credit, you can fund the upfront costs of operation. Then, you can pay off the amount owed and, after remaining out of debt for the agreed-upon timeframe, use it once again.
The simple takeaway is term loans are intended, and best for, major purchases that aren’t a regular and frequent part of doing business. Lines of credit, meanwhile, address short-term, recurring needs such as:
- Completing payroll.
- Paying utility and other bills.
- Keeping your company stocked with raw materials and components.
Common misconceptions around term loans and lines of credit
For both term loans and lines of credit it is absolutely critical that you can explain the intended purpose of the funds and how they will support your business.
Lenders have deep pockets
While many lenders have strong reserves, they need to take into account your needs and the funds of their depositors when making a decision. A risky plan or a lack of information can mean an unfavorable outcome.
Lenders are eager to fully fund every project
Depending on the circumstances, you may also need to show a willingness to invest in your own business. A lender won’t be as willing to work with you if you expect them to assume all of the risk in the partnership.
The many misconceptions tied to lines of credit
When it comes to lines of credit, keep their intended use in mind. Community banks like Adirondack Trust Company have experienced teams that will work with you to determine the best possible lending or financing product for your needs, but other lenders may simply dismiss an application.
Utilizing a line of credit for purposes better met by a term loan can make budgeting more complicated as well. The amortized nature of term loans offers a more predictable repayment strategy for major business purchases.
You should look for alternatives if you’re considering opening a line of credit for emergency purposes. Lenders issue lines of credit based on a defined and specific need, generally related to short-term working capital. While protecting your company from unforeseeable circumstances is a sound decision, it doesn’t meet that criteria.
If you want a source of credit only for emergency use, a business credit card can be a useful alternative. While this option carries higher costs in terms of interest rates, it also doesn’t usually need to be secured with an asset. And if the credit card is only used for true emergencies, the impact of the higher interest rates will be limited—and likely worth the cost of keeping your business moving in the right direction.
A partner in our community
Adirondack Trust Company takes a deeply personal approach to business lending and financing. Our team takes the time to get to know you and your business before you fill out any application, and we always look to steer you toward the product that best addresses your needs. That’s true even when it means going outside of our bank for a solution.
We want what’s best for businesses in the Adirondack region because we’re a part of the community as well. When businesses have access to key resources like loans and lines of credit, everyone benefits.
To learn more about securing your next round of business lending or financing from Adirondack Trust Company, view our available options and get in touch with us today.