Comparing and Contrasting Revolving Credit and Business Term Loans

13 Feb Comparing and Contrasting Revolving Credit and Business Term Loans

When businesses need financing, they often choose between revolving credit and term loans. Both options provide access to capital but serve different financial needs. Whether you’re managing cash flow, funding growth, or covering unexpected expenses, understanding how these financing solutions work can help you make the best decision for your business.

In this article, we’ll break down the key differences between revolving credit and term loans, comparing their advantages, drawbacks, and best use cases.

What Is Revolving Credit?

Revolving credit is a flexible financing option that allows businesses to borrow, repay, and borrow again up to a set limit. It functions similarly to a credit card—once you pay down the balance, those funds become available again for future use.

Key Features of Revolving Credit:

• Flexible borrowing: Use as much or as little as needed within the credit limit.
• Ongoing access to funds: Reuse funds as you repay them.
• Variable interest rates: Interest is charged only on the amount borrowed.
• No fixed repayment schedule: Payments vary based on usage and terms.

Common Types of Revolving Credit:

1. Business Lines of Credit – Offers flexible access to capital for working capital, inventory purchases, or short-term needs.
2. Business Credit Cards – Useful for daily expenses, travel, and small purchases with rewards and cashback benefits.

What Is a Business Term Loan?

A business term loan provides businesses with a lump sum of money that is repaid over a fixed period, usually with a set interest rate. Unlike revolving credit, a term loan does not allow for re-borrowing once payments are made.

Key Features of Term Loans:

• Fixed repayment schedule: Monthly payments remain the same.
• Predictable interest rates: Typically fixed, making budgeting easier.
• One-time lump sum disbursement: Borrow a set amount upfront.
• Longer repayment terms: Can range from 1 to 25 years, depending on the loan type.

Common Types of Term Loans:

1. Short-Term Loans (1-3 years) – Ideal for quick funding needs with faster repayment.
2. Medium-Term Loans (3-10 years) – Used for business expansion or major purchases.
3. Long-Term Loans (10+ years) – Often used for real estate or large-scale investments.

Comparing Revolving Credit and Term Loans

Revolving credit and term loans differ in how businesses access and repay funds. Revolving credit allows businesses to borrow, repay, and borrow again up to a set credit limit, making it a flexible option for managing short-term expenses and cash flow fluctuations. In contrast, a term loan provides a one-time lump sum that must be repaid over a fixed period with scheduled payments.

Below is how revolving credit and term loans compare to each other in different factors.

Borrowing Limit and Structure

• Revolving Credit: Businesses receive a maximum credit limit and can withdraw funds as needed. Once repaid, those funds become available again.
• Term Loans: Businesses receive a fixed amount upfront, and once repaid, they must reapply for additional financing if needed.

Repayment Structure

• Revolving Credit: Payments vary depending on how much of the credit is used. Some lenders require minimum monthly payments, while others offer flexible repayment terms.
• Term Loans: Require fixed monthly payments over a predetermined period, making budgeting more predictable.

Interest Rates

• Revolving Credit: Typically has variable interest rates, meaning the cost of borrowing can fluctuate. Interest is charged only on the amount used.
• Term Loans: Usually come with fixed interest rates, providing more stability in repayment costs. However, some loans may have variable rates depending on the lender and loan terms.

Best Uses

• Revolving Credit: Ideal for managing ongoing business expenses, covering seasonal fluctuations, or handling unexpected costs. Common examples include business lines of credit and business credit cards.
• Term Loans: Best suited for significant investments, such as purchasing equipment, funding expansion, or acquiring real estate. These loans provide structured financing for long-term business growth.

Approval Process

• Revolving Credit: Typically has a faster approval process with fewer requirements, making it more accessible for businesses with fluctuating financial needs.
• Term Loans: Require a more detailed application process, often involving financial statements, business plans, and credit history evaluation. The approval process can take longer but provides access to larger funding amounts.

Flexibility and Cost Considerations

• Revolving Credit: Offers high flexibility, as funds can be used repeatedly. However, interest rates may be higher over time, especially if balances are not paid off quickly.
• Term Loans: Provide structured, long-term financing with potentially lower interest rates, but lack the flexibility of reusing funds once repaid.

Both financing options have their advantages and drawbacks, so choosing the right one depends on your business’s specific needs, financial goals, and cash flow management strategy.

Revolving Credit Pros and Cons

With revolving credit, you have ongoing access to funds. You may withdraw as needed without reapplying. Your repayment is flexible. You pay based on what you use, with options to repay early. The approval process is easier to obtain than most other term loans, especially for small businesses.

The interest rates can fluctuate in revolving credit, which makes budgeting more difficult. They also have lower borrowing limits, which may not be enough for large investments. Because of their easy-to-use format, overuse is a real danger. Excessive borrowing can quickly lead to financial strain.

Term Loans Pros and Cons

Term loans offer you predictable monthly payments, which is helpful in financial planning and budgeting. Interest rates are typically lower for term loans than they are for revolving credit, especially for well-qualified borrowers. Term loans are ideal for major investments, such as purchasing equipment, real estate, or expansion.

Term loans do not have the flexibility of revolving credit; once funds are used, you must reapply for new financing. The approval process for a term loan through a business term loan lender is longer and requires detailed documentation and financial history. The loan is also a fixed amount, which can be tricky to balance. If you borrow too much, you might unnecessarily increase your costs, but if you borrow too little, you may not fully meet your business’s needs.

When to Use Revolving Credit vs. Term Loans

Whether you choose revolving credit or term loans will be different for different businesses under different circumstances.

You might want to choose revolving credit if:

• You have short-term financial needs, such as managing cash flow.
• Your expenses fluctuate, and you need ongoing access to funds.
• You want the flexibility to borrow and repay funds as needed.
• You need quick approval without extensive paperwork.

If that doesn’t feel like the right fit, you might want to consider a term loan if:

• You’re making a large investment, such as purchasing equipment or real estate.
• You prefer fixed, predictable payments to manage your budget effectively.
• You want lower interest rates than revolving credit options.
• You’re planning for long-term financial stability with structured payments.

Both revolving credit and term loans offer valuable financing solutions for businesses, but the right choice depends on your cash flow, funding needs, and financial strategy.

If you need ongoing access to capital for operational expenses, a business line of credit may be the best option.

If you require a large one-time investment, a term loan with fixed payments may be more suitable.

If you are still unsure, a business loan broker can help guide you through the decision between a business line of credit and revolving credit.