Choosing between a term loan and a line of credit depends on what you're financing. Using the wrong product costs more and can create cash flow problems.
Term loan: what it is and when to use it
A term loan provides a lump sum that you repay with fixed monthly payments over a set term (1–10 years). Interest accrues on the full balance from day one.
Use for: - Equipment purchases - Leasehold improvements - Acquisitions - Specific projects with defined costs
Advantages: - Predictable fixed payment - Lower interest rate than revolving credit - No temptation to re-borrow
Disadvantages: - You pay interest on the full amount from day one, even if you don't need it all yet - Prepayment penalties on some loans
Line of credit: what it is and when to use it
A line of credit is a revolving credit facility. You draw what you need, repay it, and draw again. Interest accrues only on the outstanding balance.
Use for: - Working capital gaps (waiting for customer payments) - Seasonal inventory needs - Bridge financing between invoices - Emergency operating buffer
Advantages: - Only pay interest on what you use - Flexible draws and repayments - Reusable — repay and redraw without a new application
Disadvantages: - Higher interest rate than term loans (typically 1–3% more) - Often requires annual cleanup (30+ days at $0 balance) - Temptation to treat it as permanent capital (risky)
Total cost comparison
$100k term loan at 8% over 36 months: total interest = $12,740 $100k line of credit at 11%, drawn 50% for 24 months: total interest = $11,000
The line of credit can be cheaper if you don't use it fully — but if you draw the full amount continuously, a term loan is significantly cheaper.
Which to choose: decision matrix
| Use case | Best choice |
|---|---|
| Equipment, vehicles, improvements | Term loan |
| Seasonal inventory build | Line of credit |
| Specific acquisition | Term loan |
| Smoothing AR collection gaps | Line of credit |
| Long-term working capital | Term loan |
| Emergency buffer | Line of credit |
Calculate monthly payments for term loans at the Business Loan Calculator.