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Every growing business hits a point where it needs outside financing. Maybe you want to buy equipment, cover payroll during a slow stretch, or handle an unexpected expense. Two of the most common types of business financing are a term loan and a business line of credit, and they work in very different ways.
A term loan hands you a lump sum you pay back on a set schedule. A business line of credit gives you a credit limit you can draw from as you need it, a lot like a business credit card. There's also a third option worth knowing about, a home equity line of credit (HELOC), which blends features of both.
I've spent years helping business owners sort through their options, and the right one usually comes down to how you plan to use the money and how you want to pay it back. Below, I break down how a term loan, a line of credit, and a HELOC each work, what they cost, and which tends to fit which situation.
What Is a Term Loan?
A term loan is essentially a single lump sum that you borrow and then pay back with regular payments. This is probably the easiest form of financing to understand. You get the loan as a single sum, then repay it over a specific period, with monthly payments made up of both principal (a portion of the original amount you borrowed) and interest.
A business term loan differs from a personal loan. Instead of using your personal income and credit history, a business term loan is based on the financial health of your company.
Most term loans have either a fixed interest rate or a variable interest rate. A fixed interest rate keeps your monthly payment exactly the same, which allows for better budget planning.
The length of the term loan can vary a lot depending on the lender. Some shorter-term loans range from six months to two years. Other longer-term loans can extend from three to 10 years.
What Is a Business Line of Credit?
With a business line of credit, you get access to a specific amount of money you can borrow from at any time, instead of receiving a single lump sum. Unlike a term loan, you don't pay interest on your entire credit limit. You only pay interest on what you actually use. This style of financing is called revolving credit.
You can use the funds you borrow from a line of credit multiple times and repay those amounts until the total you've borrowed reaches zero. At that point, you can borrow from the line again.
Revolving credit like this is a good fit for businesses looking for short-term financing. It helps you manage cash flow issues when customer payments take longer to arrive than expected, or when there are temporary cash flow shortages.
Typically, business lines of credit have variable interest rates based on the prime rate. So your rate may fluctuate over time. Be aware of additional charges, including draw fees (each time you withdraw money) and maintenance fees (to keep the account active).
When To Use a Term Loan
A term loan is a good fit when you're certain about how much you need and the loan is for something long-term or one-time. Because you'll receive a lump sum and repay it on a set schedule, it's easier to figure out your monthly payments.
Many small business owners use term loans to:
Purchase expensive items
These include things like equipment, vehicles, or property renovations.
Fund growth
Growing your business might mean opening new locations or taking on large projects.
Refinance high-interest debt
You can refinance high-interest debt into a single loan at a lower rate, which can lower your monthly payments and the total interest you pay.
Since your payments are consistent and known ahead of time, a term loan typically suits owners who prefer predictable monthly payments and don't expect to borrow again in the near future.
When To Use a Business Line of Credit
Small and mid-size businesses (SMBs) tend to benefit more from lines of credit when their expenses are ongoing or hard to predict. Because of the revolving nature of lines of credit, you can borrow money, repay it, and borrow again as often as you need to.
Small business owners commonly use lines of credit for:
Covering operating expenses
Paying for payroll, rent, and supplies during slower periods in your industry.
Handling unexpected expenses
Emergency repairs or a sudden opportunity you can't afford to pass up.
Bridging cash flow gaps
Waiting on accounts receivable when customers are slow to pay their invoices.
By only paying interest on the amount you borrow, lines of credit provide greater flexibility for short-term needs and working capital compared to term loans, especially when you're not sure when or how much you'll need.
The Hybrid Option: a Home Equity Line of Credit (HELOC)
There's a third financing option, a home equity line of credit, or HELOC. If you own real estate with enough equity in it, a HELOC lets you borrow against that equity. Essentially, a HELOC combines aspects of lines of credit and term loans.
HELOCs through Clarify Capital have a draw period of five years. During this time, you can borrow from your available limit, repay those funds, and borrow again as many times as you need without having to apply again. You can generally borrow from your limit at any time throughout most of the draw period.
Once the draw period finishes, the repayment period begins. You can't make any more draws, and you start paying back the remaining balance on the loan. Payments may be significantly larger than they were during the draw period.
The advantage is collateral. Since a HELOC is secured by your home, interest rates on HELOCs are typically lower than on unsecured lines of credit. But since your home is the collateral, missing payments could lead to foreclosure. So while a HELOC can save you money on interest, it does put your home at risk.
Term Loan vs. Line of Credit vs. HELOC
Compare these three options side by side:
| Feature | Term loan | Business line of credit | HELOC |
|---|---|---|---|
| Funding amount | A lump sum, up to $5M with Clarify Capital | A revolving credit limit, up to $5M with Clarify Capital | Based on your available home equity (home value minus what you owe) |
| Repayment terms | Fixed schedule, often 6 months to 10 years | Revolving, usually 6 to 36 months | A draw period up to five years (through Clarify), then a repayment period of 10 to 20 years |
| Interest rates | Fixed or variable, APRs starting at 6% with Clarify | Usually variable, often tied to the prime rate, as low as 6% with Clarify | Usually variable, often lower because it's secured by your home |
| Loan payments | Steady monthly payments of principal and interest | Interest only on what you draw | Small payments while drawing, then larger amortizing payments |
| Common uses | One-time, planned expenses like equipment or expansion | Ongoing or unexpected costs and cash flow gaps | Owners with home equity who want lower rates and a long, flexible runway |
| Flexibility | Low. You get the money once and repay on a set schedule | High. Borrow, repay, and borrow again as needed | High while drawing, fixed during repayment, the hybrid of the two |
These aren't the only financing options available. An SBA loan can also work for larger, long-term needs, though it takes more paperwork and time to fund.
Choosing the Right Option for Your Business
Ultimately, the decision boils down to how you plan to use the funds and how you want to repay them. Here's a simple way to think about it:
| Financing Option | Good For |
|---|---|
| Term loan | If you need a specific amount for a single one-time expense and you want fixed monthly payments on a set schedule, a term loan may be a good fit. |
| Business line of credit | If you have ongoing or unpredictable expenses and you want to borrow, repay, and borrow again as your cash flow changes, a line of credit may be a good fit. |
| HELOC | If you own a home with available equity, you want lower rates and a longer, more flexible repayment schedule than an unsecured option, and you're comfortable putting your home up as collateral, a HELOC may be a good fit. |
Whatever you decide on, a term loan, line of credit, or HELOC, the right financing can help your business keep growing and handle whatever challenges come up. Apply today to see your options in two minutes.
Frequently Asked Questions
If you're still comparing these financing options, I've broken down some of the most common questions that I hear from clients.
What Is the Difference Between a Term Loan and a Line of Credit for SMEs?
A term loan gives you a total amount of funds to cover the cost of an expense. This option is a good fit when there's a single expense you need to cover. Once you receive the funds, you pay them back over time on a set payment schedule.
A line of credit, on the other hand, lets you access cash as needed. That way, a business can use the line of credit to fund ongoing expenses. For example, you may need extra capital because of seasonal fluctuations, equipment repairs, and the like. This type of financing doesn't lend itself to a one-time large expense, but rather to smaller recurring costs.
What Are Some Drawbacks of a Term Loan?
When you take out a term loan, you receive the entire sum of funds at one time. This may seem convenient since you have all the money at once, but the downside is that the lender starts charging interest right away.
Even though you haven't used all the borrowed funds at the start of the loan, you'll still pay interest on the entire amount. Many term loan agreements also include an origination fee, as well as a penalty for paying the loan off before its maturity date.
Each term loan is structured to provide a fixed amount of funds disbursed at closing. If you need more funds later, you'd typically have to reapply for another loan to get them.
Are Loans and Lines of Credit Mutually Exclusive?
No. There are no absolutes when you compare loans versus lines of credit. Depending on how you plan to use the money, both types of financing can be good for a business. Loans tend to work for one-time expenses like buying new equipment or making leasehold improvements. Lines of credit tend to work for variable or periodic costs like rent or mortgage payments, payroll and employee benefits, or accounts payable and inventory purchases. Many companies find that using both types of financing helps them manage their working capital and liquidity.
How Is a $50,000 Home Equity Loan Different From a $50,000 Home Equity Line of Credit?
Both types of financing use your home as collateral, so you risk losing your home if you default on the loan. A $50,000 home equity loan gives you the ability to get $50,000 as a lump sum. Repayment is structured a lot like a personal installment loan. Interest rates may vary depending on the lender or market conditions when the loan is issued.
A $50,000 home equity line of credit (HELOC) lets you borrow against your property. As long as you're within the draw period (the initial time frame your lender sets), you only pay interest on what you actually borrow, not on the entire credit limit.
Can a Loan Be Used Like a Credit Card?
For traditional term loans, the answer is no. A traditional term loan gives you a lump sum of funds, and you make monthly payments on the principal and interest until the loan is paid off. But most lines of credit work a lot like a credit card. You get a line of credit, so you can borrow whatever amount you need from that line and only pay interest on what you borrow. Once you repay the borrowed amount, your available credit limit is restored.
Is My Information Safe When Applying With Clarify Capital?
Yes. Clarify follows SOC 2 security principles to protect your confidential financial information. A U.S.-based lending advisor handles your application personally and communicates with you directly throughout the process. You won't be routed through any automated phone systems or chatbots.
Bryan Gerson
Co-founder, Clarify
Bryan has personally arranged over $900 million in funding for businesses across trucking, restaurants, retail, construction, and healthcare. Since graduating from the University of Arizona in 2011, Bryan has spent his entire career in alternative finance, helping business owners secure capital when traditional banks turn them away. He specializes in bad credit funding, no doc lending, invoice factoring, and working capital solutions. More about the Clarify team →
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