If you own a business or startup, you’ve likely wondered if a small business loan meets your needs. There are many funding options out there for small business owners and each is different. Two terms you might have seen are “installment” and “revolving.”
So are small business loans installment loans or revolving credit? And what’s the difference between the two?
Let’s explore the specifics of installment and revolving loans, including interest rates, repayment options and the types of loans that might work best for your business needs.
Is a Small Business Loan Installment or Revolving Credit?
In short, a small business loan can be either installment or revolving credit. Two common types of small business loans are term loans and lines of credit. A small business term loan is a type of installment loan. A small business line of credit is a type of revolving credit.
Installment loans provide a single lump sum of funding. Borrowers are given a repayment schedule and payments are made in installments over the course of a few months or years. Typically, installment loans are used for large, one-time expenses such as equipment upgrades or funding an expansion. They can be either secured loans or unsecured loans.
On the other hand, a revolving line of credit provides ongoing access to funds rather than a single lump sum. Business owners can tap the available funds as needed, only paying interest and fees on what they borrow. Typically, lines of credit are used for ongoing expenses such as day-to-day operational costs. They can either be secured or unsecured.
Small Business Installment Loan vs. Small Business Line of Credit
A small business line of credit and a small business installment loan are two types of financing options available to small businesses. Here’s how the two differ.
Small Business Installment Loan
Predictable payments. A small business installment loan offers a lump sum of money up front, which is typically repaid over a fixed period in regular, equal installments. Business owners receive the full loan amount at once and then make scheduled payments until the loan is paid off.
Fixed interest rates. These loans usually come with a fixed interest rate for the entire term. This means that the interest rate remains constant, so you’ll know exactly how much you need to pay each month.
Higher loan amounts. These loans help you finance by providing access to larger sums of money compared to lines of credit. The loan amount is determined up front based on the business’s needs and financial situation.
Long-term common uses. Installment loans are ideal for funding one-time investments or projects, such as purchasing equipment, expanding your business or financing a major renovation. These loans are structured as long-term commitments, and do not work well for frequent purchases.
Small Business Line of Credit
Revolving funding. A small business line of credit provides business owners with a credit limit, like a business credit card. Business owners can borrow funds up to the approved limit, and only pay interest on the funds they use. Once you repay the borrowed amount, the credit becomes available for use again.
Variable interest rates. Interest rates for lines of credit are usually variable and may be tied to a benchmark rate, such as the prime rate. Businesses are charged interest only on the outstanding balance, so if they don’t use the full credit line, they won’t incur interest on unused funds.
Lower loan amounts. Credit limits for small business lines of credit vary but are generally smaller than installment loans. The amount a business can access depends on factors like creditworthiness and business performance.
Short-term common uses. Lines of credit are suitable for managing cash flow fluctuations, covering short-term operational expenses, or taking advantage of immediate business opportunities. They provide flexibility as funds can be used for various purposes as needed.
What Are the Pros and Cons of Installment Loans for Small Businesses?
Installment loans have unique pros and cons for small businesses. The right financing option for you will depend on your business’s specific needs.
Larger funding amounts. The main benefit of installment loans is that they typically offer larger upfront amounts of money than revolving credit, such as lines of credit and credit cards. These funds are provided in a single lump sum, making them a good option for large one-time expenses.
Predictable payments. Your monthly payments are often made on a set date with a set amount due each time. There are fewer surprises with these loans, so you can forecast and budget for your business much more easily.
Longer terms. Longer repayment periods are available and can range anywhere between a few months to several years, which can reduce monthly payment amounts.
Potential for lower interest. Installment loans may have lower interest rates compared to payday loans or other financing options, providing cost savings over time.
Rigid terms. When taking on an installment loan, the fixed repayment schedules may not accommodate your fluctuations in cash flow. This may make it difficult to make payments at times.
Higher interest rates. Fixed rates can be higher than variable rates depending upon the lender. This can lead to greater interest expenses over time.
Limited flexibility. With installment loans, funds are received as a lump sum, so they aren’t very suitable for ongoing purchase needs.
Collateral requirement. Some lenders may ask for collateral to secure the loan, such as a vehicle or valuable property, which can be risky for small business borrowers.
Prepayment penalties. Depending upon the lender, some loans have penalties for early repayment. This limits the flexibility of paying off the loan ahead of schedule.
What Are the Pros and Cons of Lines of Credit for Small Businesses?
Lines of credit also have unique benefits and disadvantages for small businesses and typically offer more of the following than a term loan.
Flexibility. Lines of credit offer flexibility, allowing businesses to draw funds as needed and only pay interest on the amount borrowed.
Fast access. Once approved, you can access your funds quickly, making it a quick solution for unexpected expenses or business opportunities.
Seasonality. Lines of credit allow you to keep funds on hand for busy periods and repay based on what you use. This can also help potentially reduce financial strain during slow periods.
Potential for lower operating costs. Interest is only charged on the amount borrowed, potentially reducing overall interest expenses compared to traditional loans.
Variable interest rates. Interest rates can be variable, making it challenging to predict future borrowing costs.
Credit limits. Lines of credit come with predetermined credit limits, which may not cover larger investments or projects.
Risk of overuse. Easy access to credit can lead to overborrowing and increased debt if not managed carefully.
Renewal requirements. Lines of credit may require periodic renewals or reviews of creditworthiness, which could lead to changes in terms or even closure.
When Is an Installment Loan a Good Option for a Small Business?
An installment loan is a great option for when your business has clear, specific objectives that require financing. These objectives can include the following.
- Expanding into new markets
- Opening additional locations
- Launching a new product line
- Purchasing equipment
- Paying your additional employees
These loans are also excellent for long-term projects, since they offer longer repayment terms compared to other types of loans or credit options.
When Is a Line of Credit a Good Option for a Small Business?
Lines of credit are ideal for managing day-to-day operational expenses, covering gaps in cash flow, and addressing emergencies. They are also a great opportunity for:
- Managing normal cash flow
- Seasonal businesses
- Emergency funding
- Taking advantage of opportunities
- Flexible financing
DISCLAIMER: The information in this article is provided for educational and informational purposes only, without any express or implied warranty of any kind, including warranties of accuracy, completeness or fitness for any particular purpose. The information in this article is not intended to be and does not constitute financial, legal or any other advice. The information in this article is general in nature and is not specific to you the user or anyone else.
This content is for educational and informational purposes only, and is not intended as financial, investment or legal advice.