When starting a business, it's important to know what types of options one can acquire for their business models to take flight and generate more income.
Term Loan vs. Line of Credit: What's the difference?
A bigger reason that sets these two loans apart from each other is in the repayment of each loan.
With a term loan, a business is issued a fixed amount in cash, which the business can use any way it deems necessary toward its operations. Once the funds are depleted, the business must either apply for a new loan amount or choose to continue without a loan in place.
Either way, the money must be paid back on a schedule determined by the lender. This repayment schedule can be measured as monthly, even daily depending on the loan.
One type of Term Loan that gives upfront cash to businesses based on their revenue is called a Merchant Cash Advance, almost like a payday loan for businesses.
In this loan, there are lenders who will approved a business on a cash advance by considering the business' bank statements and credit card statements as collateral to approve the loan.
With a good payment history, the balance can be replenished once it falls below 50% of its allotted loan amount, and sometimes even the originally approved loan amount is extended to a higher dollar amount by the lender if the borrower wishes to take on more risk for the company, typically make bigger purchases and provide working cash flow to maintain future operations.
When a business gets a term loan, we like to think of this as a bucket of water that a business pays for upfront in terms of paying the interest rate. If a business gets $100,000 in a Term Loan, the business will be forced to pay back the $100K principal plus all the interest (with or without a pre-payment penalty).
Pre-payment refers to the loan principal being paid back before the life of the loan is complete.
LINE OF CREDIT
A Line of Credit is different than a Term Loan because the borrower only has to make payments on whatever they draw from the line of credit, just like a water well they can dip into for funds at any given time vs the Term Loan being served as a bucket of water that the borrower pays for in full no matter how they use the loan.
Furthermore, a line of credit is an amount granted to a business to be used as needed. If a business is given a $100,000 line of credit in the form of a credit card, that business can decide exactly how much of it they want to use, and their usage will determine how much interest they will pay on whatever the balance is that they take out.
Monthly payments only kick in once the line of credit has been used. This gives the Line of Credit a more flexible repayment method as well, with the borrower having the ability to make a minimum payment (only 1% of the balance plus interest), a payment higher than required minimum payment, or pay the balance in full at the end of the pay period, just like a "charge card".
Types of Loans
A set amount of funds plus any given interest that a borrower is responsible for repaying in full with regular payments over a set period of time.
o Interest ranges from as low as 5% in some states to as high as 49% in others.
o Payback period usually occurs within 1 to 5 years depending on the lender.
o Term Loans are approved based on the amount
Line of Credit
A set maximum amount of funds that a borrower can utilize for funds whenever they want, and is responsible for repaying back only whatever funds they draw from the line of credit.
o Can be Secured (collateral) or Unsecured (no collateral)
o Typically have lower interest rates than Term Loans depending on the type of credit line issued: Traditional or Non-Traditional.
Based on the amount of Equity that specific collateral, inventory, account receivable, and/or other balance-sheet Asset has for the Lender to leverage for a loan.
o This loan is disbursed as either a Term Loan or a Line of Credit to the borrower.
o Interest rates are usually lower based on this Secured Loan in comparison to an Unsecured Loan, where an Asset being pledged as collateral for the Secured loan lowers the risk for the lender to recuperate by liquidating the collateralized assets to recover funds issued on the loan if the borrower (God forbid!) defaults on the loan and doesn't pay back.
o This loan's repayment period is determined by the lender, usually based on the borrower's creditworthiness with times ranging from as little as 1-3 years (Hard Money Loan) and even higher up to 30 years (Mortgage).
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