In previous posts, we explored six short-term financing options. Now, let’s take a closer look at a question many business owners face: Should you choose a line of credit or a traditional loan?

Every growing business needs funding at some point, and navigating the options can be challenging. Understanding the differences between a line of credit and a traditional loan — and knowing which fits your business’s needs — is key to making the right choice.

What is a Line of Credit?

A line of credit is a common funding option. A lender assigns a credit limit similar to a credit card that you are allowed to spend. This means that the borrowed amount can be used, repaid, and then used again. Once you have this new line of credit, you can spend it on whatever you feel is most necessary for your business, such as:

• Purchasing new inventory or refilling current stock.
• Financing a new marketing strategy.
• Extra cash for seasonal fluctuations.

Generally, a line of credit is used when you need extra money for short-term expenses. This is why they have higher interest rates and lower average dollar amounts.

It is important to note that there are two types of lines of credit, secured and unsecured. To acquire a secured line of credit, your business will need to pledge specific assets as collateral to “secure” the funds. As lines of credit are normally short-term liabilities, the lender will ask that the collateral be a short-term asset like inventory.

Getting an unsecured line of credit is harder to acquire as it does not require collateral. To ensure that the lender has some security, the lender will need a lien or a personal guarantee that payments will be made. A strong personal credit score may be required to get an unsecured line of credit.

What is a Regular Loan?

Loans are non-revolving, large lump sums of money only issued once. You are then required to make principal and interest payments until the debt is fully paid off. Loans can also be both secured and unsecured. A traditional loan from a bank, for example, will always require some form of collateral.

Another downside to regular loans is that they can only be used for a singular purpose. That means if you get a loan to help with payroll, you won’t be able to use a cent of that money to buy inventory or fix equipment.

What are THE Lines of Credit Advantages and Disadvantages?

Last week, we explored some tradeoffs that come with short-term financing options, but let’s dive deeper into how a line of credit can impact your business.

Advantages

Pay For What You Need:

A line of credit allows your business to have a maximum balance that is the highest estimated cost you will need to cover everything. Then, you will only pay interest on the amount you need and use.

Boost Cash Flow:

A line of credit is a simple way to ensure that even during a down month or quarter, you are still able to pay everything on time. Businesses that are heavily impacted by the seasons often make the most out of this type of financing.

Work Around Your Timeline:

With a line of credit, you can withdraw as much as you need at any point in time. Then, you have the ability to pay it back on your own timeline with interest (this varies).

Improved Credit:

To get more favorable loans, you will often need a higher credit score for the application. A great way to build that score is by establishing a positive credit history with a business line of credit by making payments on time.

Disadvantages

Interest Rates:

I mentioned this earlier, but one of the most significant drawbacks to a line of credit is how high the average interest rates are. These rates are variable, and depending on the term length, credit amount, and your credit score, it could be more than 25% in some cases.

Lower Limits:

Another common pain point businesses associate with lines of credit is that there is a much lower limit compared to a traditional loan through a bank, for example.

While the advantages of a line of credit can appear to outweigh the disadvantages for its specific use cases, this does not stop businesses from rightfully worrying about some potential pitfalls.

Are There Risks in a Line of Credit?

There are risks associated with all types of loans. I suggest all businesses watch out for hidden risks lenders won’t warn you about, such as a monthly maintenance fee. While the initial cost to secure a line of credit is relatively low, the variable interest rates that rise with the larger market can end up being more expensive than anticipated. One other risk that often gets overlooked is not making your minimum payments. This can lead to the line being closed entirely and liability for your business or for you as an individual. So, how does a line of credit get paid back? Because you are borrowing in increments, you will repay that original amount, then borrow again as long as the line remains open.

One way to avoid some of the risks associated with a business line of credit is to go through a reliable and trustworthy alternative financing source. Many alternative lenders offer a wide range of credit limits. Some alternative lenders will also tailor business financing to your needs by adjusting payment options for daily, weekly, or semimonthly payments. The lines of credit also offer unlimited terms and feature a soft credit pull that will not affect your credit score.

What’s Easier to Get, a Regular Loan or a Line of Credit?

For many businesses, the key question is simply: what will I qualify for? One of the biggest advantages of a line of credit is the flexibility it offers, making it well-suited for the often unpredictable cash flow of smaller businesses. While newer or smaller companies may face challenges securing a traditional bank loan, they often find it easier to access a line of credit, providing quicker and more adaptable funding when they need it most.

While both a business line of credit and a traditional loan have their advantages and risks, the right choice depends on your business’s needs, growth stage, and cash flow patterns. For many small- and mid-sized businesses, a flexible line of credit can provide the capital needed to stay agile and ready for opportunities.

To explore tailored options and find the financing solution that works best for your business, OwnerCo’s lending partners can guide you through the process — helping you access the right credit, on terms that fit your operations and growth plans.