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Loans vs lines of credit

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Key takeaways:

  • As you start a business and manage operations, you’ll need funding which can come in a loan or a line of credit.
  • Loans are typically better for a specific large expense while a line of credit offers more flexibility and can be used for smaller expenses.
  • By considering your business expenses and what timing works best, you can decide if a loan or line of credit would be better for your business needs.  

Starting a business can be thrilling. You’re turning your idea into a working business – but before you can bring it to life, you need financing.

There are two options you can consider – a loan or a line of credit.

A loan allows you to borrow a lump sum of money all at once and then pay it back over a specific period of time. There are different types of loans (more on that later), but in general, that‘s the gist of it.

On the other hand, you can opt for a business line of credit, which is similar to a credit card, but with the bank as the lender. You have access to a specific amount of financing, but you don’t make payments until you use some of the funds in your line of credit.

So how do you decide which one is best for your business? Consider a few of the following points:

  • What are the expenses? Loans are typically used for a very specific purpose. For example, if you’re looking to purchase an expensive piece of equipment, you should consider a loan. MidWestOne even offers loans specifically for equipment.

If you’re going to make a number of small purchases over time as you operate your business, the line of credit may be the better option. A line of credit offers more flexibility as to what expenses are being made for your business.

  • When are you paying it back? Loans are typically good for long-term expenses while lines of credit are good for short-term expenses. For a loan, you begin to pay it back immediately according to your loan’s payment terms. These payments may be fairly small considering you can typically pay back the loan in the long term. For a line of credit, you pay once you begin using the funds in your line of credit. If you’re not using it, then you don’t have payments to make.

That means if your business is just starting to acquire inventory and won’t make returns early on, a loan may be the best option. Likewise, if you’re just making small expenses that you can pay off as soon as your receivables come in, a line of credit may be the best bet.

  • What is your collateral? Regardless of which option you choose, your lender will need you to show collateral for your business. This might even affect which one works best for you. This is something your banker can help you figure out.
  • How much do you want to spend in upfront costs? A line of credit typically has a lower interest rate and smaller closing costs than a loan. However, if you miss a payment on your line of credit, your interest rate could go up whereas a loan’s interest rate is typically fixed unless you select a variable rate.
  • Have you considered various loan types? Not all loans are created equal. MidWestOne has several business loan options. For example, MidWestOne participates in Small Business Administration (SBA) loan programs, which means quicker processing and local decision making. This is a great, customizable option for start-ups as it requires less in the upfront, but it does require more documentation and government protocol.

The MidWestOne team can help answer your questions about which loan option or line of credit is right for your business. Visit your local MidWestOne branch for more information.

MidWestOne Bank does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.