Both are common ways to borrow, but they solve different problems — using the wrong one for your situation means paying for flexibility you don’t need, or not having flexibility you do.

Term Loan: When You Know Exactly What You Need

A term loan is a lump sum of money you borrow upfront and repay on a fixed schedule with a fixed (or sometimes variable) interest rate. It’s designed for a specific, one-time investment where you know the exact amount needed.

Typical Uses

Equipment purchases ($15,000–$150,000)
Facility buildouts or renovations
Business acquisitions or significant inventory purchases
Vehicle purchases for your fleet

Term Loan Example

A landscaping company needs a new truck and trailer for $45,000. They take a 5-year term loan at 7.5% APR. Their monthly payment is fixed at $891, and they know exactly what they owe each month. The full interest cost over 5 years is approximately $8,460. Because the investment directly generates revenue (the truck enables new jobs), the predictable, amortized cost is easy to factor into their business model.

Key Characteristics

Repayment: Fixed monthly payments over a set term (typically 2–7 years for small business)
Interest calculation: You pay interest on the full borrowed amount from day one
Approval process: Typically requires collateral and a clear business plan for how you’ll use the funds
APR range: 4%–10% for established businesses with good credit; 8%–15% for newer or riskier borrowers

Line of Credit: For Unpredictable Cash Flow Needs

A line of credit is a revolving credit limit you draw from as needed, similar to a business credit card but usually with better rates and higher limits. You only pay interest on what you’ve actually drawn, and you can redraw funds as you repay.

Typical Uses

Covering payroll during seasonal slow periods
Bridging the gap between invoicing clients and getting paid (accounts receivable financing)
Managing unexpected expenses without disrupting operations
Taking advantage of early-payment discounts from suppliers
Handling temporary inventory gaps before peak seasons

Line of Credit Example

A marketing agency has steady work but uneven cash flow. Clients pay 30–60 days after invoicing, but payroll is due biweekly. The owner secures a $25,000 line of credit at 8% APR. In January (slow month), she draws $8,000 to cover payroll. She repays $2,000 in February when client payments arrive, then draws another $5,000 in March. Interest accrues only on the amount drawn: roughly $53 in January ($8,000 × 8% ÷ 12), then $43 in February on the remaining $6,000. She’s only paying for the money she actually used, when she needed it.

Key Characteristics

Repayment: Flexible; you pay a minimum monthly amount plus interest on your balance
Interest calculation: Only on the drawn amount; unused credit costs nothing
Approval process: Usually faster; may require personal guarantee but often less collateral than a term loan
APR range: 6%–12% for established businesses; 10%–18% for newer businesses
Draw and redraw: As you repay, your available credit replenishes

The Cost Difference in Real Numbers

Suppose you need $20,000 and expect to use it sporadically over 12 months.

Term loan at 7% APR over 3 years: Monthly payment $617; total interest paid $2,212. You pay this even if you only need the money for 6 months.
Line of credit at 8.5% APR, drawn as needed: If you average $10,000 drawn (half your limit), your annual interest is approximately $850. Over 12 months, you’re paying roughly $850 in interest, not $2,212.

The difference: $1,362 saved by using the right tool. For a small business operating on thin margins, that’s meaningful.

A Practical Hybrid Approach

Many established small businesses use both simultaneously:

Term loan: For planned, capital investments (equipment, buildout, vehicle) where the ROI is clear
Line of credit: As a standing safety net for predictable cash flow timing gaps — payroll, accounts receivable gaps, seasonal dips

This approach ensures you’re not overpaying for unused flexibility on your term loan, and you’re not scrambling to secure emergency credit when cash flow stutters. The line of credit also serves as a backup if an unexpected opportunity or expense arises.

How to Choose

One large, specific expense? Term loan.
Recurring, unpredictable cash flow gaps? Line of credit.
Both? You can usually carry both without issue, especially as your business matures.

Ask your lender about the full cost of each option for your specific situation — rates and terms vary significantly based on industry, credit history, and business stage. A few hours of comparison shopping can save thousands.