Small businesses often narrow financing choices down to two popular tools: a business line of credit and a business loan. Both can support growth and stabilize cash flow, but they work differently—and those differences matter when you’re deciding what to apply for and how you’ll repay it.
This guide breaks down how each option works, the real pros and cons, and a simple framework to help you choose the best fit.
What a business line of credit is (and how it works)
A business line of credit is a flexible, revolving account—often compared to a credit card—where you can borrow, repay, and borrow again up to a set credit limit. You typically pay interest (and sometimes fees) only on what you actually borrow, not on the full approved limit.
Two common structures you’ll see
- Draw period + repayment period: You can take draws for a set window (often one to several years), then once the draw period ends you stop borrowing and repay the remaining balance over a fixed time.
- Ongoing line with per-draw repayment: You can keep accessing the line, but each draw is repaid over its own fixed term (for example, 6 or 18 months). Payments cover principal plus accrued interest/charges for that specific draw.
Because you can pull funds “as needed,” lines of credit are commonly used for working capital, ongoing projects, and unexpected expenses.
Pros and cons of a business line of credit
Pros
- Flexible use: Often usable for many business expenses (inventory, supplies, equipment, payroll), as long as it’s business-related.
- May be unsecured: Some lines don’t require collateral.
- Interest applies only to what you use: Borrow a little, pay interest on a little.
- Ongoing access to funds: Once open, it can act like a safety net for surprises or opportunities.
Cons
- Overspending risk: Easy access can lead to using credit too quickly—especially if spending doesn’t produce revenue.
- Limit uncertainty until approval: You won’t know your final credit limit until you apply and are approved, which can be a problem if you need a specific amount.
- Possible extra fees: In addition to interest, some lenders charge draw fees, monthly/annual fees, or inactivity fees.
What a business loan is (and how it works)
A business loan is typically an installment loan: you receive a lump sum upfront and repay it in regular installments. If you want more money later, you generally apply for a new loan.
Business loans can be:
- Secured (backed by collateral—like equipment, a vehicle, or real estate)
- Unsecured (no specific collateral pledged)
Loans are often a better match when you have a specific, larger purchase or project in mind, and they may offer higher amounts and longer repayment periods than a line of credit, which can reduce payment strain on cash flow.
Pros and cons of a business loan
Pros
- Broad use for business purposes (especially unsecured loans): Many loans can be used for various business needs; some secured loans are purpose-built for buying an asset that becomes collateral.
- Lump sum can fund bigger projects: Loans may provide larger amounts suited for expensive purchases and expansions.
- Fixed rate + predictable payments (often): Many business loans have set repayment terms with consistent payments, making budgeting easier—and they can sometimes carry lower rates than a line of credit.
Cons
- Interest begins immediately on the full amount: Once funded, interest accrues on the whole loan—even if you didn’t end up needing every dollar.
- Collateral may be required: Secured loans require pledging assets; some lenders may use a UCC blanket lien that ties up business assets as security.
- Less payment flexibility: Fixed payments are predictable, but you can’t easily “dial down” payments during tight months, which can strain cash flow.
- Personal guarantees are common: Many lenders require owners to personally guarantee repayment if the business can’t pay.
How to decide: a simple matching framework
Choose a line of credit when…
- You want ongoing access to funds for shifting needs
- You don’t have one single “big purchase,” but instead have recurring expenses
- You want to minimize interest costs by borrowing only what you need, when you need it
Examples: smoothing payroll gaps, buying inventory in waves, covering seasonal slowdowns, handling emergencies.
Choose a business loan when…
- You have a specific purchase or project with a defined budget
- You want a large lump sum and a structured payoff plan
- You prefer stable, predictable payments and a clear payoff date
Examples: equipment purchase, major renovation, expansion costs, large one-time supply order.
Three questions to ask before you apply
- Why do you need financing?
Ongoing access and flexibility often points to a line of credit; a single large purchase often points to a loan. - What repayment structure fits your cash flow?
Lines of credit may offer lower minimums and flexibility; loans are commonly fixed and predictable. - Can (and should) you provide collateral?
Secured financing can sometimes offer higher limits and better pricing—but you’re putting assets at risk if revenue dips.
Eligibility reality check
Lenders often look at personal and business credit, time in business, and overall financial position. Personal guarantees are also common for both loans and lines of credit.
It may be easier to qualify for a line of credit than a loan in some cases, but loans may offer higher total amounts if you qualify.
Bottom line
- A line of credit is best for flexibility and repeat access—ideal for working capital, ongoing expenses, and “just-in-case” funding.
- A business loan is best for defined, larger needs—ideal when you want a lump sum, longer repayment, and predictable payments.