In short
- A term loan pays you one lump sum that you repay on a fixed schedule, whether you use the money right away or not.
- A line of credit gives you a limit to draw from; you usually pay interest only on the amount you have drawn.
- For one planned purchase, a term loan is often simpler and can carry a lower rate. For uneven, repeating needs, a line is usually cheaper overall.
- Compare total dollars paid, not just the rate. Fees, draw charges and how long you carry a balance change the answer.
Two tools, two jobs
Business owners often ask which is better, a line of credit or a term loan. The honest answer is that they do different jobs. A term loan is built for a single, known cost: a renovation, a second location, a partner buyout. A business line of credit is built for costs that come and go: payroll in a slow month, a supplier order you did not see coming, the gap between finishing a job and getting paid for it.
Picking the wrong one does not usually sink a business, but it can cost real money. Borrow a lump sum you do not need yet and you pay interest on idle cash. Use a revolving line to fund a five-year project and you may end up carrying a balance at a higher rate for far longer than planned. This guide walks through how each works, what each costs, and how to tell which one fits.
How a term loan works
With a term loan, the lender pays out the full amount at the start. You then repay it in fixed instalments over an agreed term, often monthly, sometimes weekly. Each payment covers interest plus part of the principal, so the balance falls steadily until it reaches zero. This is called amortization.
- Amount: fixed at the start. If you need more later, you apply again.
- Rate: fixed or variable, set from your revenue, time in business, credit and the lender's view of risk. Illustrative range: roughly 8% to 30% APR, depending heavily on the profile.
- Term: anywhere from several months to several years. Longer terms mean smaller payments but more total interest.
- Interest: charged on the full outstanding balance from day one, whether the money is sitting in your account or already spent.
The strength of a term loan is predictability. You know the payment, you know the end date, and you can budget around it. Many lenders also price term loans a little lower than revolving credit for the same business, because the repayment path is fixed.
How a line of credit works
A line of credit gives you a limit, for example $100,000. You draw what you need, when you need it, up to that limit. You pay interest on the amount drawn, not on the whole limit. As you repay, the available credit frees up again, and you can draw again. That is what "revolving" means.
- Amount: flexible, up to your limit. Draw $5,000 one week and $30,000 the next.
- Rate: often variable. Illustrative range: roughly 8% to 25%, depending on the lender and your file.
- Fees: some lines charge an annual or maintenance fee, a draw fee each time you pull funds, or an inactivity fee if you never use the line. Read the fee schedule, not just the rate.
- Repayment: varies. Some lines ask for interest-only payments while you carry a balance; others turn each draw into a short repayment schedule of its own, for example six or twelve months.
- Review: lenders may review the line each year and can reduce or close it if the business weakens.
The strength of a line is that you only pay for what you use. The risk is that it is easy to keep a balance running for years, using short-term credit for long-term needs.
A worked example: same business, two approaches
All figures below are illustrative, rounded, and chosen to show the mechanics. Your actual offers will differ.
A small manufacturer expects to need up to $60,000 during a busy stretch in the spring and summer to buy raw materials before customers pay. The rest of the year it needs nothing extra. The owner is weighing two options.
Option A: a $100,000 term loan at 12% APR, 12 months
The owner borrows $100,000 to be safe. At 12% APR, amortized monthly over 12 months, the payment works out to about $8,884.88 a month. Over the year that is about $106,618.55 in payments, so total interest is roughly $6,618.55. The business pays interest on the full declining balance from the first month, including all the months when it did not actually need the money.
Option B: a $100,000 line of credit at 14%
The line carries a higher rate in this example, 14%. The owner draws only as needed. Month-end balances over the year look like this:
| Months | Balance drawn | Interest per month (14% / 12) |
|---|---|---|
| Months 1-2 | $0 | $0 |
| Month 3 | $20,000 | about $233.33 |
| Month 4 | $40,000 | about $466.67 |
| Months 5-6 | $60,000 | $700 each |
| Month 7 | $40,000 | about $466.67 |
| Month 8 | $20,000 | about $233.33 |
| Months 9-12 | $0 | $0 |
Total interest for the year: $2,800. The average balance was only $20,000, so even at a higher rate, the line cost less than half of what the term loan did in interest. If the line had a $500 annual fee, the total would be $3,300, still well below the term loan in this example.
What the example shows, and what it does not
The line won here because the need was temporary and uneven. Flip the facts and the answer flips. If the manufacturer needed the full $100,000 on day one to buy a machine and would use it for years, the line would carry a large balance at a higher rate for the whole period, and a term loan (or equipment financing) would likely come out ahead. The rate matters, but how much you borrow and for how long usually matters more.
When a term loan tends to fit
- You have one defined cost with a clear price: a build-out, an acquisition, a vehicle, a large marketing push with a set budget.
- You want a fixed payment you can put in the budget and forget about.
- The money will be put to work right away, so you are not paying interest on idle cash.
- You would be tempted to keep drawing on an open line and want a hard end date.
- You are refinancing a more expensive short-term balance into something slower and more predictable.
When a line of credit tends to fit
- Your cash needs rise and fall with seasons, projects or customer payment cycles. See our seasonal business funding guide.
- You want a safety net for surprises, such as a broken compressor or a delayed customer payment, without borrowing until it happens.
- You buy inventory on short notice when a good price comes up.
- You can repay draws within a few months, so the balance regularly returns to zero.
Common mistakes to avoid
Borrowing the maximum "just in case" on a term loan
Extra cash feels safe, but on a term loan you pay interest on all of it. If your real need is uncertain, a line or a smaller loan plus a line can cost less.
Using a line of credit as permanent capital
If your line never goes back to zero, it has quietly become a long-term loan at a revolving rate, and the lender can reduce it at review time. That is a sign to move the stable part of the balance into a term loan.
Comparing rates that are not measured the same way
Some short-term products quote a factor rate or a monthly fee instead of an annual percentage rate. Put every offer into total dollars paid over the life of the money. Our guides on factor rate vs APR and how to read a business loan offer show how.
Ignoring the fee schedule
Origination fees on term loans, and draw or annual fees on lines, can change which option is cheaper, especially on smaller amounts.
Can you have both?
Yes, and many established businesses do. A common setup is a term loan for the long-lived purchase and a modest line of credit for day-to-day swings. Lenders look at total debt payments against your cash flow, so having one may affect how much you can get on the other. Our guide on how much your business can borrow explains the numbers lenders look at.
What lenders look at for each
Requirements vary by lender and by country, but the basics overlap: time in business, monthly revenue shown in bank statements, personal and business credit, existing debt, and industry. Lines of credit can be a little harder to get for very new businesses, because the lender is committing to a limit you can use at any time. In the US, some term loans come through the SBA programs described on sba.gov; in Canada, the Canada Small Business Financing Program supports term loans and lines of credit through participating lenders. Government-backed options usually take longer but can carry better terms; see government-backed loans.
Having your documents ready speeds up either option. Our documents lenders need checklist covers the usual list.
How CELER Funding can help
CELER Funding is a free referral service, not a lender. We look at what you need the money for and how your cash moves through the year, then match you with lenders in our network across Canada and the US who offer term loans, lines of credit, or both. Lenders may pay us when a deal closes; that does not change what you pay. You can see several options side by side on our compare page, or start a free application and talk it through with us.
This guide is general information, not financial, legal or tax advice. Every lender sets its own terms, and the numbers above are illustrative only.