A business owner needs $250,000. One lender offers a term loan, another offers a line of credit, and the rates look similar. They are not the same product, and choosing the wrong one is one of the more expensive ordinary mistakes in business finance.
The deciding question is not which is cheaper. It is what the money is for.
What is a business line of credit?
A line of credit is a revolving facility: you draw what you need, repay it, and draw again, up to a limit. Interest accrues only on the outstanding balance, and the limit replenishes as you repay. It is designed for recurring, temporary cash needs, funding receivables and inventory between paying suppliers and getting paid.
What is a term loan?
A term loan is drawn once as a lump sum and repaid on a fixed amortisation schedule over a defined period. Once repaid, it is gone. There is nothing to redraw. It is designed for one-time, long-lived purchases: equipment, an acquisition, a build-out.
What is the actual difference?
| Line of credit | Term loan | |
|---|---|---|
| Draw pattern | Repeatedly, up to a limit | Once |
| Repayment | Flexible; interest on the balance | Fixed amortisation |
| Interest charged on | Outstanding balance only | Full principal from day one |
| Typical term | 1–2 years, renewable | 3–7 years |
| Extra fees | Unused line fee, monitoring | Origination, prepayment |
| Rate | Usually floating | Fixed or floating |
| Best for | Working capital swings | Assets and one-time projects |
| Risk on renewal | May not be renewed | Committed for the term |
The matching rule
Match the life of the financing to the life of the thing it funds. That single principle prevents most bad structuring decisions.
- A machine that runs for seven years should be funded over a term that resembles seven years, not on a revolver that gets reviewed annually.
- Receivables that turn over every 45 days should be funded by something that revolves with them, not amortised over five years.
Get this backwards and both failure modes hurt:
Term loan for working capital. You borrow a lump sum to cover a seasonal gap, then amortise it for four years. You are paying principal on money you needed for four months, and when the next season comes you have no availability left, the facility doesn’t replenish.
Revolver for equipment. You buy a machine on the line of credit. The asset is on the balance sheet for years, but the borrowing sits on a facility that gets reviewed annually. If the lender reduces or declines to renew the line, you owe a large balance against an asset you cannot quickly sell.
What does each actually cost?
The headline rate is only part of it. A line of credit carries an unused line fee on the undrawn portion, so committing to more than you need has a real price. Asset-secured lines add collateral monitoring and field-exam costs, plus the internal cost of producing borrowing base certificates, the mechanics of which are in the borrowing base certificate.
A term loan usually carries an origination fee and often a prepayment penalty. If you intend to refinance in eighteen months, that exit cost may matter more than the spread.
Compare across every fee line rather than on rate alone, term sheet anatomy shows where the real cost hides.
Which one is easier to obtain?
Credit teams generally treat them differently. A term loan is underwritten on whether cash flow can service a fixed schedule for years, which puts weight on stability and coverage. A revolver, particularly an asset-secured one, is underwritten on collateral quality and turnover, which can work for businesses whose earnings move around.
That is the same divide covered in cash flow lending vs asset-based lending: a business that cannot support a term loan may still support a revolver, and the reverse is true for asset-light service companies with strong, steady earnings.
What about covenants?
Term loans generally carry maintenance financial covenants tested quarterly for the life of the loan. Revolvers vary: bank lines often carry similar tests, while asset-based revolvers sometimes carry only a springing covenant that applies when availability falls below a threshold.
More covenants means more ways to default, and the difference is worth pricing. See loan covenants explained, and run the headroom calculation before signing either.
The renewal risk nobody prices
A term loan is committed for its term. A line of credit is typically reviewed annually, and the lender can reduce it, reprice it, add conditions, or decline to renew.
That flexibility runs one way. In a soft year, exactly when you most need the facility, a revolver can shrink or disappear, while a term loan simply continues. If a line of credit is load-bearing for your operations, know your renewal date and start the conversation months ahead of it, not weeks.
Can you have both?
Yes, and it is the most common healthy structure: a revolver sized off working capital for the day-to-day swings, plus a term loan for the equipment or the acquisition. They serve different purposes and are usually cheaper together than forcing one product to do both jobs.
The practical read
Ask two questions:
- Will I need this money again after I repay it? If yes, you want a revolver.
- How long will the thing I’m buying last? Fund it over something like that horizon.
If your answer is “I need working capital that revolves and I’m buying a machine,” that is two facilities, not one compromise.
Run your own file first
Not sure which structure fits, or whether you’re carrying the wrong one now? Run the assessment or send us your financials and we’ll give you the read.
Educational only. Nothing here is an offer of credit, a commitment to lend, or advice on any specific transaction. Terms, fees, and structures vary by lender and situation.