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Business loan versus line of credit

Business financing is a critical aspect of running a successful business. When businesses require financial support, they have the option to choose between business loans and business lines of credit. Although both these options provide funding when required, they differ in the way they function.

Business loans offer a lump sum amount that must be repaid with interest over time, while business lines of credit provide access to a pool of funds that businesses can use from as required, up to a specific limit.

As each option caters to different business needs, it’s essential to choose the right one. This article aims to highlight the differences between business loans and business lines of credit to assist businesses in choosing the financing option that best suits their needs.

What is the Business Line of credit ?

A Business Line of Credit is a type of loan that helps businesses manage their money. It’s like having a pool of money that they can take from whenever they need it. They only have to pay interest on the money they use, not the entire amount they are approved for. This is good for businesses because they can take out money when they need it and pay it back later, without worrying about big loan payments.

For example, if a business has a Business Line of Credit for Rs. 10 lakhs and they only need Rs. 2 lakhs to buy some supplies, they can just take out the Rs. 2 lakhs and pay interest on that amount. They can pay it back over time when they make money from their business.

A Business Line of Credit is especially helpful for businesses that have times when they don’t make as much money, like during slow seasons or when they’re just starting out. It’s also good because the interest rates are usually lower than regular loans. This means businesses can save money on interest and use it to grow their business instead.

What is a Business Loan?

A business loan is a form of financing that provides businesses with a lump sum of money, which is paid back over time with interest. Businesses can use this type of loan for a variety of purposes, such as purchasing equipment, buying inventory, or expanding the business. For example, a bakery might take out a business loan to purchase a new oven or hire additional staff during peak seasons.

Business loans can be secured or unsecured, with secured loans requiring collateral, such as property or equipment, to secure the loan. Unsecured loans, on the other hand, do not require collateral but may have higher interest rates.

Repayment terms and interest rates for business loans vary based on the lender and the business’s financial situation. Typically, loans are repaid in monthly installments over a set period of time, ranging from a few months to several years.

Overall, a business loan is a useful tool for businesses that need a set amount of money for a specific purpose and have a solid plan for repayment. By providing upfront capital, businesses can achieve their goals and expand their operations, ultimately increasing their revenue and profitability.

Here are the key differences between a Business Loan and a Business Line of Credit:

a. Fixed vs. Flexible Amounts: Business loans offer a fixed amount of money, which is determined by the lender at the time of application. This lump sum must be paid back over a set period of time with interest. In contrast, business lines of credit offer a flexible amount of money that can be borrowed as needed, up to a set limit. This can be useful for businesses that have unpredictable cash flows or need to cover unexpected expenses.

Example: A small business owner in India needs to purchase new equipment to expand their operations. They apply for a business loan of INR 5,00,000 from a bank and are approved for the full amount. They receive the money and begin paying it back over a set period of time. Alternatively, if the same business owner had a business line of credit, they could borrow smaller amounts of money as needed to cover the cost of equipment purchases or other expenses.

b. Repayment Terms: Business loans typically have fixed repayment terms, meaning the borrower knows exactly how much they need to pay back each month over the life of the loan. Business lines of credit, on the other hand, have more flexible repayment terms that are based on the amount borrowed.

Example: A business owner in India takes out a business loan with a repayment term of 36 months. They know they will need to make fixed monthly payments over the next three years to pay back the loan. In contrast, a business line of credit may have varying repayment terms depending on how much money the business owner borrows.

c. Interest Rates: Business loans often have higher interest rates than business lines of credit due to the longer repayment terms and the risk involved. Business lines of credit usually have lower interest rates because they offer a more flexible borrowing option.

Example: A business owner in India applies for a business loan with a bank and is offered an interest rate of 15%. In contrast, if the same business owner applied for a business line of credit, they may be offered a lower interest rate of 8-10%.

d. Funding Time: Business loans typically take longer to fund than business lines of credit. It can take several weeks or even months to receive the full amount of a business loan, while business lines of credit offer more immediate access to funds.

Example: A business owner in India needs to cover a sudden expense and applies for a business loan. They may have to wait several weeks for the loan to be approved and the funds to be disbursed. In contrast, if they had a business line of credit, they could withdraw the necessary amount of funds almost immediately.

e. Usage Restrictions: Business loans often come with usage restrictions, meaning the money can only be used for a specific purpose outlined in the loan agreement. Business lines of credit typically offer more flexibility in terms of how the funds can be used.

Example: A business owner in India takes out a business loan to purchase new inventory. They cannot use the loan funds for any other purpose besides purchasing inventory. In contrast, a business line of credit could be used to cover a variety of expenses, including payroll, rent, and marketing.

f. Application Process: The application process for business loans and business lines of credit can differ, with business loans often requiring more extensive documentation and a longer processing time. Business lines of credit may have a simpler application process and faster approval times.

Example: A business owner in India applies for a business loan with a bank and is required to provide a detailed business plan, financial statements, and collateral. The application process can take several weeks. Alternatively, if they apply for a business line of credit, the application process may be simpler and faster, requiring only basic financial information and a credit check.

How do I apply for a Business Line of Credit in India?

To apply for a Business Line of Credit in India, you will need to follow a few simple steps. First, you need to approach your bank and express your interest in applying for a Line of Credit. You can apply for a business line of credit by visiting the nearest branch of your bank, applying online through the bank’s website, or calling Refer Loan. We can assist you with every step of the process, from determining your loan amount eligibility to completing the necessary documentation and obtaining loan approval without any hidden charges.

Next, you will need to submit all the required documents. The documents may include your business registration certificate, PAN card, GST certificate, bank statements, and income tax returns, among others. The bank will also check your credit score to assess your creditworthiness.

Once the bank has received your application and verified your documents, they will evaluate your creditworthiness and your ability to repay the loan. The bank will then determine the amount of credit you are eligible for, as well as the interest rate that you will be charged.

If your application is approved, the bank will provide you with the Line of Credit, and you can use the funds as needed. It’s important to note that you will only be charged interest on the amount of money you withdraw, and not on the entire credit limit.

Overall, the application process for a Business Line of Credit in India is relatively simple and straightforward, provided you have all the necessary documentation and meet the bank’s eligibility criteria.

How do I apply for a Business Loan in India?

If you’re a business owner seeking financial support, a business loan could be a viable option. However, before applying for a loan, there are several steps you can take to increase your chances of approval and find the best loan product for your business.

First, it’s essential to determine your funding needs. By assessing how much money you need to borrow and what you plan to use it for, you can narrow down your search to the loan products and lenders that are most suitable for your business.

Next, you should check your personal and business credit scores. Your creditworthiness will be evaluated by lenders to determine your eligibility for a loan. A good credit score will increase your chances of approval and help you get more favorable loan terms.

Once you have a clear understanding of your funding needs and creditworthiness, you can research different loan options. There are various types of business loans, such as term loans, SBA loans, and lines of credit. By researching the different types of loans and lenders that offer them, you can find the best fit for your business.

After identifying the right loan product and lender, it’s time to gather the required documents, such as financial statements, tax returns, bank statements, and a business plan. Having these documents on hand before applying can streamline the application process.

You can apply for a loan online by filling out an application form and submitting the required documents electronically. Alternatively, you can visit the lender’s branch in person and fill out an application form there.

Once you’ve submitted your application, the lender will evaluate your creditworthiness and the financial health of your business. This process can take several days to several weeks, depending on the lender.

If your loan application is approved, the lender will provide you with the funds you need. Before accepting the funds, make sure to read the loan agreement carefully and understand the terms and conditions of the loan. By following these steps, you can increase your chances of obtaining a business loan that meets your financial needs.

What are the advantages of Business Loan?

Here, we are discussing the various benefits or advantages that business loans can offer to business owners.

Helps in managing working capital and expanding the business

Business loans are an excellent way to obtain funding to manage working capital and expand the business. In addition, the loan can help maintain cash flow during difficult times. By having access to funds, businesses can continue to operate, meet expenses, and take advantage of growth opportunities.

Maintains cash flow during difficult times

Businesses often experience fluctuations in revenue due to factors such as seasonal trends, changes in the economy, or unexpected events like natural disasters. Business loans can provide much-needed cash flow to sustain operations during lean periods.

Offers flexibility with long-term and short-term loans

Business owners can apply for various types of loans, such as long-term and short-term loans, depending on their financial requirements. Short-term loans usually have a tenor of one year, while long-term loans can extend up to five years or more. This flexibility allows businesses to choose a loan tenor that best suits their estimated calculations.

Interest rates are competitive and depend on the loan tenor, collateral, and creditworthiness

Business loans are available at attractive interest rates from banks and Non-Banking Financial Companies (NBFCs). The interest rate usually depends on the loan tenor, collateral, and creditworthiness of the borrower. Alternative finance options like NBFCs also provide loans with nominal processing fees and without any pre-payment penalty. This makes borrowing more affordable and can help businesses save on lending costs.

Convenient repayment options

Business loans come with convenient repayment options, making it easier for businesses to repay the loan. Borrowers can work out a repayment plan that suits their business efficiency, and even the periodic EMIs can be lowered or increased based on profitability. There are also easy modes of payout options, such as signing up for an auto-debit facility through electronic funds transfer from a bank account.

Collateral-free loans are available from alternative financing companies

Alternative financing companies like NBFCs offer collateral-free loans. This means that small business owners can avail of funds without providing collateral. This makes it easier for small businesses to access funding and sustain their ventures.

Boosts the flexi loan limit of the business for the future

Paying off short-term business loans can increase the business’s flexi loan limit, which can improve the likelihood of obtaining larger financing options in the future if necessary. This can help businesses access more significant funding opportunities when they need it. By building credibility with small loans, businesses can position themselves for larger loans in the future.

Enhances business credibility and growth

Having access to funding through business loans can enhance business credibility and growth. With adequate funding, businesses can take advantage of growth opportunities, increase revenue, and expand operations. This, in turn, can lead to better credit ratings, more financing options, and further growth opportunities.

What are the advantages of Line of credit?

Line of credit has several advantages that borrowers can benefit from.

Lower Interest Rates:

A line of credit offers a lower interest rate compared to traditional loans, making it an affordable option for borrowers who require funds. This can save borrowers a substantial amount of money in interest charges over time.

Flexibility:

One of the significant benefits of a line of credit is its flexibility. Borrowers can take out smaller amounts of money as needed, rather than being required to borrow a minimum amount set by the bank. Borrowers can also use the money for any purpose they desire.

Low Risk for Self-Employed Individuals:

Self-employed individuals can benefit significantly from a line of credit since they can take out smaller amounts of money and set up their businesses with lower risk. This provides a sense of financial security and peace of mind.

Access to Funds:

With a line of credit, borrowers have access to a substantial amount of money in the bank that they can claim at any time if required. This can be useful for businesses that may experience unexpected expenses or cash flow issues.

Alternative to Personal Loans:

For borrowers who are hesitant to take out a personal loan due to high-interest rates charged by lenders, a line of credit can be a good alternative. It provides access to funds at a lower interest rate.

Higher Credit Limit:

The credit limit on a line of credit is generally much higher than the limited loan amount offered in traditional loans, providing more financial flexibility and greater access to funds for borrowers. Borrowers can use the credit limit to finance a variety of expenses, including home repairs, business expansion, or education costs.

Business Loan versus Line of credit – Which one is better?

When deciding between a business loan or a line of credit, the amount of funding you need is an important factor. Business loans generally offer higher amounts of funding, making them a good choice for one-time large purchases like equipment or real estate. If you need smaller amounts for multiple purchases over time, a line of credit may be a better option.

Another factor to consider is the repayment timeline. If you need a longer repayment period, a business loan may be a better fit. However, if you need to repay the loan quickly, a line of credit may be more appropriate.

Predictability is also important to consider. If you prefer a fixed payment plan, a business loan is the better choice. On the other hand, if you have consistent cash flow and don’t mind variable payments, a line of credit may be more suitable.

Your intended use of funds is also important. If you have a specific purpose for the funds, like purchasing inventory, a business loan may be more appropriate. However, if you need cash for multiple or ongoing needs, a line of credit may be the better choice.

When it comes to interest rates, business loans generally have lower rates than lines of credit. However, the interest rate you qualify for depends on various factors, including your creditworthiness and repayment history.

Both business loans and lines of credit may require collateral and personal guarantees, meaning you may be personally liable for repayment if your business cannot make payments. It’s important to carefully consider the risks before taking out a loan or line of credit.


So,Overall, the decision to choose between a business loan and a line of credit depends on your business needs and financial situation.
If you have a one-time large purchase, need longer repayment periods and prefer predictable payments, then a business loan may be more suitable. On the other hand, if you have multiple or ongoing needs, have consistent cash flow and don’t mind variable payments, then a line of credit may be more appropriate. Additionally, you should carefully consider the available APRs and the potential collateral and personal guarantee requirements before making a decision.

Here’s an example

Suppose you are a business owner in India and you need to fund the purchase of a new piece of machinery for your factory. The cost of the machinery is quite high, so you need a substantial amount of funding. In this case, a business loan may be more appropriate as it offers higher funding amounts compared to a line of credit. Additionally, since this is a one-time purchase, a business loan would be suitable for your needs.

However, if you need to make smaller purchases over an extended period, such as buying raw materials or inventory, a line of credit may be more appropriate. For example, if you are a retailer and you need to purchase inventory regularly to keep your shelves stocked, a line of credit would allow you to access funds as needed, without having to take out a larger loan each time.

It’s important to consider the repayment period when choosing between a business loan and a line of credit. If you need a longer repayment period, a business loan may be more appropriate, while a line of credit would be suitable if you need to repay the funds quickly.

When it comes to predictability, a business loan offers a fixed payment plan, which can be beneficial if you want to plan your budget and expenses accordingly. On the other hand, a line of credit offers variable payments, which may be more suitable if you have consistent cash flow.

Finally, it’s important to be aware of the risks associated with taking out a loan or line of credit. Both options may require collateral and personal guarantees, which means you could be personally liable for repayment if your business is unable to make payments. It’s crucial to understand these risks before taking out a loan or line of credit and to ensure that you are comfortable with the terms of the agreement.

What type of business need to avoid Line of Credit?

A business line of credit can be a useful financing option for many businesses, but there are some cases where it may not be the best choice. Here are a few examples of who should avoid a business line of credit:

  • Startups: If you’re a new business without an established credit history or consistent cash flow, you may have trouble getting approved for a business line of credit.
  • Businesses with irregular cash flow: If your business experiences fluctuations in revenue throughout the year, a business line of credit may not be the best option as you may struggle to make consistent repayments.
  • Businesses with limited collateral: Business lines of credit often require collateral, which can be a challenge for businesses with limited assets.
  • Businesses with a history of missed payments: If your business has a poor credit history or a record of missed payments, you may struggle to qualify for a business line of credit, or you may face high interest rates and unfavourable repayment terms.

It’s important to consider your business’s financial situation and needs carefully before applying for any type of financing, including a business line of credit.

FAQs

What is the procedure for repayment of Line of credit?

The repayment procedure for a Line of Credit is similar to a credit card. Once you withdraw a portion of the loan’s credit limit, a repayment deadline is set.

Let’s say you have a line of credit (LOC) with a credit limit of Rs. 50,000. You withdraw Rs. 10,000 from your LOC to pay for some business expenses. The lender sets a deadline for you to repay the amount you borrowed along with interest, usually in the form of equated monthly installments (EMIs).
Now, if you need to withdraw more funds from your LOC before repaying the initial amount, you can do so. For example, you decide to withdraw an additional Rs. 15,000 to purchase inventory. In this case, you will be charged interest only on the total amount borrowed, which is Rs. 25,000 (Rs. 10,000 + Rs. 15,000). You will need to repay this amount along with interest within the specified timeframe.
It’s important to keep in mind that the interest rate for a LOC is typically higher than that of a term loan since it is a form of revolving credit. Therefore, it’s important to use the funds wisely and only withdraw what you need to avoid accumulating unnecessary debt.

What are the differences between a loan and a line of credit?

Loans and lines of credit differ in their design and purpose. A loan is intended for a specific need, such as financing a car or home, while a line of credit offers a borrowing limit that can be used as needed and repaid repeatedly. Additionally, loans generally have higher closing costs compared to lines of credit. Ultimately, the better option depends on the borrower’s specific needs.

When is it appropriate for a business to utilize a line of credit?

A line of credit is useful for obtaining short-term financing. Typically, businesses use this funding to support operational expenses such as supplies, payroll, or to increase their inventory.

Is it possible for a small business to obtain a line of credit?

Absolutely, various options exist for small businesses to obtain lines of credit. Many major banks that cater to small businesses, community banks, credit unions, and online lenders such as OnDeck offer business lines of credit.

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