Is a Small Business Loan an Installment Loan or Revolving Credit?
Ezra Cabrera | July 25, 2024
When you're thinking about a small business loan, you might ask yourself: Is it like a one-time payment plan or more like a credit card?
A business loan for small companies can actually be either.
With an installment loan, you get a lump sum of money and pay it back over time in fixed amounts—great for big, planned expenses.
On the other hand, revolving lines of credit works more like a credit card, giving you flexible access to funds up to a set limit, perfect for handling everyday expenses and surprises.
This article will break down the differences and help you figure out which option is best for your business.
Key Takeaways
- A business loan for small companies come in two primary forms: installment loans and revolving credit. Installment loans provide a fixed sum repaid over a set period, while revolving credit offers ongoing access to funds up to a credit limit.
- Installment loans are ideal for significant, planned investments like equipment or real estate, offering predictable monthly payments and fixed interest rates. However, they lack flexibility and may require collateral.
- Revolving credit, including business line of credit and credit cards, offers flexibility for managing operational costs and unexpected expenses, but typically comes with higher interest rates and the risk of overuse leading to debt cycles.
What is a Small Business Loan?
Small business loans serve as financial aids that enable businesses to fill cash flow gaps, handle operational costs, or finance marketing campaigns.
They cater to a wide range of financing needs, spanning from long-term investments in commercial real estate to short-term resolutions for immediate cash flow problems.
Essentially, a small business loan can be categorized into two primary types: installment loans and revolving credit.
The loan amounts for a business loan can vary significantly, ranging from as little as $1,000 to as much as $5 million.
Financial institutions such as Small Business Administration (SBA), banks, credit unions, and online lenders offer these loans to small business owners, providing them with the necessary capital to grow and sustain their enterprises.
Types of Small Business Loans
Before getting a business loan, it's crucial for the business owner to know the options available. Several types of small business loans are available, each fashioned to meet specific business requirements. A term loan and small business line of credit are among the most common options.
Term loans, also known as small business installment loans, provide a fixed amount of capital that is repaid over a predetermined period with regular payments.
These loans are ideal for large, planned investments such as purchasing equipment or expanding business operations.
Conversely, a business line of credit provides a flexible financial solution for businesses. They come with set limits and draw periods, allowing businesses to borrow, repay, and borrow again as needed.
This type of revolving credit can be used as working capital to pay for operational expenses or manage cash flow fluctuations.
SBA loans, backed by the U.S. Small Business Administration, can also be either installment or revolving, providing competitive rates but often requiring a lengthy application process.
Other types of small business loans include:
Equipment financing loans, which are secured by the equipment being purchased and tend to have lower interest rates
Merchant cash advances, which offer quick funding based on credit card sales but come with high fees
Invoice factoring, where businesses sell their invoices to a lender at a portion of their value to bridge cash flow gaps.
What is an Installment Loan?
An installment loan provides a single lump sum of funding that is repaid over a set period through regular monthly payments. These loans can be secured, requiring collateral, or unsecured, relying on the borrower’s credit score, income, and debt.
The repayment schedule for an installment business loan is fixed, including the timely payments of both principal and interest, with a set end date.
Installment loans are frequently used by small businesses for hefty one-time expenses like equipment purchase, business expansion, or significant investments.
The predictability of fixed monthly payments helps in managing budgets more effectively, making installment loans a preferred choice for planned, large-scale investments.
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Benefits of A Business Installment Loan
One of the primary benefits of a small business installment loan, is the predictability they offer. Here are some reasons why:
Fixed monthly payments make budgeting easier
They allow businesses to plan their finances with confidence
This consistent payment structure helps manage monthly budgets more effectively
It reduces the risk of unexpected financial strain
A business installment loan offers several advantages for companies:
Access to larger sums of money, which is crucial for significant investments or business expansions
Predictable repayment schedules and fixed interest rates, protecting businesses from fluctuations in interest rates
Stability for businesses looking to make substantial investments without the worry of variable interest rates
These advantages make business installment loans particularly useful for large, planned investments.
Furthermore, installment loans typically have longer repayment terms, which can result in lower monthly payments spread over a more extended period.
While this might increase the total interest paid over the life of the loan, it provides the borrower with manageable, predictable payments that can be planned for in advance.
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Drawbacks of Installment Loans
Despite their advantages, installment loans come with certain disadvantages. One significant disadvantage is their rigid repayment structure.
Unlike revolving credit, which allows for flexibility, installment loans require the same payment amount each month, which can be challenging for businesses with unpredictable cash flows.
Some other disadvantages of installment loans include:
High interest rates
Longer repayment terms
Potential for prepayment penalties
Limited borrowing options
It’s important to carefully consider these disadvantages before deciding to take out an installment loan.
Many installment loans have several disadvantages, including:
The requirement of collateral, which puts a business’s assets at risk if they fail to meet the repayment terms
Missed payments can significantly harm a borrower’s credit history, making it more difficult to secure future loans or credit
Lack of flexibility in repayment terms
Potential prepayment penalties if the borrower decides to pay off the loan early
These factors should be considered before taking out an installment loan.
How Installment Loans Work in Practice
Consider a small business looking to purchase new equipment to expand its operations. By securing a business installment loan, the business can obtain the necessary funds to make the purchase without depleting its working capital. The business then repays the loan over a set term with fixed monthly payments, allowing it to manage its budget and plan for future expenses confidently.
What is Revolving Credit?
Revolving credit provides ongoing access to funds within a predetermined credit limit, allowing businesses to borrow as needed and repay to replenish the credit.
This type of financing is particularly useful for managing day-to-day operational costs or unexpected expenses.
Common forms of revolving credit include business lines of credit and business credit cards. Another example is SBA lines of credit.
With revolving credit, businesses can enjoy the following benefits:
Only paying interest on the amount borrowed, making it a flexible option for managing cash flow fluctuations
The option to choose between secured revolving credit, which requires collateral, or unsecured revolving credit, with no collateral required
The ability to manage varying expenses without the rigidity of fixed monthly payments
This flexibility makes revolving credit an attractive option for small businesses, as they can also benefit from revolving loans.
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Benefits of Revolving Credit
Flexibility stands out as the main advantage of revolving credit. Businesses can draw funds as needed, repay them, and borrow again, making it an ideal solution for short-term financing needs and cash flow management.
This flexibility allows businesses to handle unexpected expenses or take advantage of immediate business opportunities without undergoing a lengthy loan application process.
Another advantage is that businesses only pay interest on the funds they actually use, rather than the entire credit limit. This can result in significant cost savings compared to traditional loans, where interest is calculated on the total loan amount.
In addition, revolving credit can help businesses navigate periods of fluctuating expenses or unexpected costs, providing a safety net for operational continuity.
Revolving credit is useful for:
Managing ongoing operational costs due to its flexible repayment terms
Businesses with seasonal fluctuations in revenue, allowing them to access funds during slow periods and repay them when business picks up
Maintaining smooth operations and seizing growth opportunities as they arise
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Disadvantages of Revolving Credit
Just like any other small business loan, an evolving line of credit has its own set of disadvantages. One major disadvantage is the typically higher interest rates compared to installment loans. This is due to the flexible and ongoing nature of revolving credit, which can make it more expensive over time.
There is also a risk of overuse, as businesses might be tempted to rely heavily on revolving credit, leading to a cycle of debt. High credit utilization rates can negatively impact a business’s credit score, making it more difficult to secure future financing.
On top of that, a revolving line of credit often involves variable interest rates, which can fluctuate and make financial planning more challenging. Some potential risks of using revolving credit include:
Overuse and reliance on credit, leading to a cycle of debt
Negative impact on credit score
Difficulty securing future financing
Fluctuating interest rates, making financial planning more challenging
It is important for businesses to carefully consider these risks before utilizing revolving credit.
How Revolving Credit Works in Practice
A small business might use a revolving line of credit to manage seasonal fluctuations by providing funds when sales are low and replenishing the credit line when business picks up.
For example, a business could use revolving credit to cover payroll during slow seasons, ensuring they can meet their financial obligations even when revenue is down.
A revolving credit line can be used for:
Purchasing inventory during periods of higher demand, allowing businesses to restock quickly without waiting for cash flow from sales
Taking advantage of immediate business opportunities
Managing unexpected expenses, such as emergency repairs or urgent purchases, without disrupting cash flow
This flexibility makes revolving credit a valuable tool for businesses.
Comparing Installment Loans and Revolving Credit
Installment loans and revolving credit come with distinct benefits and shortcomings, making each of them suitable for different business requirements.
Installment loans provide a lump sum of money that must be repaid over a set term with fixed monthly payments, making them ideal for large, planned investments.
In contrast, revolving credit offers a credit limit that can be repeatedly borrowed against and repaid, providing flexibility for managing operational costs and unexpected expenses.
The key differences between these two types of financing include payment structures, interest rates, and flexibility.
While installment loans offer predictability and stability, revolving credit provides ongoing access to funds and adaptable repayment terms.
Understanding these differences is crucial for choosing the right financing option for your business.
Installment loans have the following benefits:
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Fixed payment amounts that include both principal and interest, which are paid at regular intervals
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Predictability that helps businesses manage their budgets more effectively and plan for future expenses with confidence
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Consistent payment structure that makes budgeting easier and reduces the risk of unexpected financial strain.
Revolving credit, on the other hand, involves variable monthly payment structures depending on the amount borrowed and repaid. Payments can fluctuate based on credit limit usage, which can lead to variable monthly costs. This flexibility allows businesses to manage cash flow fluctuations more effectively, making payments more manageable due to only paying interest on the funds used.
Choosing the Right Business Financing Options For Your Company
Selecting the right financing option for your business hinges on several factors, including your financial situation, loan purpose, and cash flow needs.
Understanding the differences between installment loans and revolving credit can enable small business owners to make informed decisions that coincide with their particular needs.
There is no one-size-fits-all answer; the key is to evaluate your business’s unique circumstances and financial goals.
Key steps in this decision-making process include assessing your financial health, identifying the exact purpose of the loan, and evaluating your cash flow requirements.
By carefully considering these factors, you can identify the most suitable financing solution to support your business’s growth and stability.
Evaluating your business’s financial health is the first step in choosing the right loan. This involves understanding your revenue, profitability, and existing debt-to-income ratios.
Reviewing your business’s credit score is also vital, as it can influence your eligibility for different loan products.
For small business owners with bad credit, exploring both installment loans and revolving credit options may be beneficial to determine which best suits their needs.
A comprehensive evaluation of factors like your financial history, credit score, and revenue forecasts can help ascertain which loan type is more sustainable for your business.
A clear understanding of these elements can guide you in choosing a financing option that aligns with your business’s financial capabilities and growth plans.
The Verdict: Is a Small Business Loan An Installment Loan or Revolving Credit?
In the end, small business loans can take the form of either installment or business term loans, or revolving credit, depending on the business’s specific needs and circumstances. Term loans, a type of installment loan, are typically used for large, one-time expenses, while lines of credit, a form of revolving credit, are often utilized for ongoing operational costs.
The decision between an installment loan and revolving credit should be based on factors such as the loan purpose, repayment terms, and cash flow requirements. Installment loans offer a lump sum and come with a predetermined repayment schedule, making them great for planned investments where you can expect predictable payments.
In contrast, revolving credit offers flexibility and ongoing access to funds, best suited for managing fluctuating, ongoing expenses, and short-term needs.
Understanding the differences between installment loans and revolving credit is essential for small business owners seeking to make informed financial decisions. By carefully assessing your financial situation, determining the purpose of the loan, and evaluating your cash flow needs, you can choose the financing option that best supports your business’s growth and ensures the long-term success of your business.
Common Questions. Straight Answers.
Lines of credit for small businesses offer flexibility, fast access to funds, ability to manage seasonality, and potential for lower operating costs, making them a valuable financial tool.
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