Small businesses often require financial assistance to manage their cash flow, expand their operations, or cover unexpected expenses. This is where loans come into play, offering a source of financing that can help small business owners achieve their goals. However, not all business loans are created equal. Two types of loans commonly available to small businesses are installment loans and revolving lines of credit. In this article, we’ll explore the differences between these two loan types and which one may be best for your needs.
What Is an Installment Loan?
An installment loan is a type of loan in which the borrower receives a lump sum of money upfront and repays it over a set period in fixed payments, known as installments. Interest is usually charged on the outstanding balance each month until the loan is fully paid off. Each installment payment typically includes both principal and interest, with more of the payment going towards interest at the beginning of the repayment period.
Installment loans are commonly used for larger purchases or investments because they offer a more predictable repayment schedule than other types of loans. The most common example of an installment loan is a mortgage – borrowers receive a large sum of money upfront to purchase a home and then pay back the loan over 15-30 years in fixed monthly installments.
What Is a Revolving Line of Credit?
A revolving line of credit (LOC) is another type of loan that provides small businesses with access to funds on an ongoing basis. Unlike an installment loan, which offers a lump sum upfront that’s paid back over time, a revolving LOC allows borrowers to draw funds as needed up to a certain limit.
With a LOC, borrowers only pay interest on the amount they’ve borrowed each month and can reuse their available credit once they’ve repaid what they owe. For example, if you have access to $50,000 through your LOC but only borrow $25,000, you only pay interest on the $25,000. If you later pay back $10,000 of that balance, your available credit increases to $35,000.
Revolving lines of credit are commonly used by small businesses for short-term financing needs such as inventory purchases, seasonal expenses, or unexpected costs. They offer more flexibility than installment loans because borrowers can access funds as needed and only pay interest on what they’ve borrowed.
Which Is Right for Your Business: Installment Loans or Revolving Lines of Credit?
Choosing between an installment loan and a revolving line of credit depends on the nature of your financing needs. Here are some factors to consider:
If you need a large sum of money upfront for a specific purchase or investment, an installment loan may be a better choice. This is because the total amount is provided in one lump sum, while with a LOC you may need to continually draw from it which could be more difficult than simply receiving all the funds at once.
On the other hand, revolving lines of credit work best when there are ongoing expenses such as payroll or inventory that require borrowing on a regular basis.
Installment loans have fixed repayment schedules. This means that each month’s payment will be the same until the loan is paid off. This type of repayment schedule is helpful if you need a predictable monthly expense so you can plan accordingly.
Revolving lines of credit do not have fixed repayment schedules as they don’t set payments over time like an installment loan does. That being said, when looking to close out your account with your lender there may be requirements to get down to zero dollars owed or repay within a certain timeframe so be sure to check with your specific lender about their policies around this.
Interest rates vary based on many factors such as business revenue history, personal credit score and other perceived risks associated with lending money to small businesses. That said, installment loans are typically secured which means they have lower interest rates than unsecured lending options like the revolving line of credit. However, if you only use a portion of the LOC available to you and pay back the loan quickly, your total interest expense could be lower than with an installment loan.
If your business has good credit history or a high credit score, it may qualify for better rates on both types of loans. Keep in mind that some lenders require collateral for installment loans, so if your business lacks assets to secure the loan with you will need a high personal credit score if this is the case. Revolving lines of credit often rely more on cash flow projections than other factors such as collateral meaning that businesses that demonstrate strong revenue histories can obtain financing even without collateral.
Both installment loans and revolving lines of credit offer small businesses important sources of financing for their various needs. The choice between these two types of loans depends on what suits your business’s individual circumstances best. We hope this article has helped you understand some key differences between these types of loans!
Are small business loans installment or revolving?
It depends on the type of loan.
What is an installment loan?
An installment loan is a type of loan where the borrower receives a lump sum and pays it back in regular payments, usually monthly.
What is a revolving loan?
A revolving loan is a line of credit that can be used repeatedly as long as the borrower makes payments on time.
How do I know if my small business loan is installment or revolving?
Check your loan agreement or contact your lender to find out what type of loan you have.
Can small businesses get both installment and revolving loans?
Yes, many lenders offer both types of loans to small businesses.
Which type of loan is better for small businesses?
It really depends on the needs of your business. Installment loans are good for one-time expenses, while revolving loans are good for ongoing cash flow needs.
Are interest rates higher for installment or revolving loans?
It varies depending on the lender and the borrower’s creditworthiness, but generally revolving loans have higher interest rates because they carry more risk for lenders.
Can installment loans help improve my credit score?
Yes, making timely payments on an installment loan can improve your credit score because it shows you can handle debt responsibly.
Do I need collateral for an installment or a revolving loan?
It depends on the lender and the amount of money you’re borrowing, but some lenders may require collateral for both types of loans.
Can I pay off an installment loan early?
Yes, most lenders allow borrowers to pay off their loans early without penalty. This can save you money on interest over time.