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A lot of people have been asking me what the difference between a business loan and a business line of credit is. So today, I will cover that and much more. Hey, everybody, welcome to my channel. I am your host, Leo Landaverde, business coach and outsource CFO, helping you scale your business. If you’re ready to grow your business to seven figures and beyond, while creating the financial freedom and the lifestyle you want, then subscribe to this channel and don’t forget to hit the bell, and you’ll be notified every time a new video comes out. This is Leo Landaverde with Greenland Advisory, creating more profit, more value, and more freedom for your business. Today, we’re talking about business loans versus lines of credit.
There’s a question that comes up a lot in dealing with clients, so I wanted to make this video to clarify things. Business loan or line of credit? So what is a business loan? A business loan or term loan provides capital to start, support, or expand a business. The loan is made for a specific amount of money and is repayable over a predetermined period of time. Whether that is two years, three years, five years, seven years, 10 years, depending on the size of the loan, term loans are good option for businesses with predictable long-term expenses. So if you can actually predict your cashflow rate, your burn rate, and you know what your cashflow is going to be, a business loan makes sense. What is a line of credit?
A line of credit is like a credit card in that the lender approves you for a specific credit limit and you withdraw the money as you need it and make payments only on the amount that you withdraw. Lines of credit are a good choice for business owners who need cash now or might need quick access to more in the future, but they’re just not quite sure how much they need. And why would you get alone if you’re not really sure of the use of it? And that’s really the big dilemma as to why we’re making this video. So the main differences. Okay? So pay attention. Interest rates. For loans, interest rates typically have a fixed interest rate so that your payment stays the same throughout the whole term of the loan and rates don’t change.
It’s really easy for accounting purposes because depending on the type of lender that you deal with, you can get an amortization schedule. Every month you’ll know exactly how much of the payment, which is fixed, will go into the principal and how much it goes into interest. And if a loan is fully amortized, you’ll know exactly when you’re going to pay off that loan, you know exactly how much interest get booked in your accounting software every month, and how much the principal reduction is going to be with every payment. How about lines of credits? Well, lines of credits, on the other hand, often have variable interest rates based on the prime rate.
And although the interest rate is usually lower for a credit line versus a loan, your payment might go up and down because it’s a variable rate. So that may be something to think about. So we’ll get more into the pros and cons in a little bit. So as far as the loan structure and the repayment, we’re going to start with loans. Loans are fairly straightforward. You’ll get an interest rate that we talked about before and then you get a fixed term, whether that is three, four, five, six, seven years or longer, and you make a monthly payment, which is the same every month, which leads to an amortization schedule. Now, on a line of credit, they work differently. Similar to a credit card, the lender sets the limit. Now, if you’re late, that limit can go down, which is different than a fixed loan.
Once you get the money, the loan is not going to change because you already get to use all the capital. But in a line of credit, say, you got a line of credit for $100,000 and you’re already used $10,000. Well, if you don’t manage your credit well and you’re not making payments on time and then you’re late, the lender may actually reduce or close your line of credit. So I suggest if you’re going to go with a line of credit, you want to set up some type of ACH payment to ensure that the lender will always get their money on time. It behooves you to have a great relationship with your lender, particularly if you have a line of credit, because you may need to increase that credit line at some point in the future. Secured or unsecured? I did a whole nother video that I would encourage you to watch.
There’s going to be a link at the end of this video so you can watch it. There’s a difference between secure and unsecured. I’m not going to get into that right now, but what we will talk about is the fact that you need to know exactly what you’re getting into. You read the fine print. If you’re secured, it’s probably going to be secured in assets or general assets of the business, or is it really going to be a unsecured? It may be unsecured, but then it’s personally guaranteed. So when you’re shopping for your loan or line of credit, there’s four things that you need to keep in mind. Annual fees. Annual fees are not charged in loans, but they are charged in lines of credit, and that is explained in detail when you sign your line of credit agreement.
They have to disclose all of those fees. Down payment. Well, if it is a loan, you will require a down payment because the lender may say, “Look, I’m going to give you 80% loan to the value of disaster,” which means you need to come up with 20% or whatever amount is and they will limit their exposure by only limiting how much they’ll go against the value of the asset. Prepayment penalties. I haven’t really seen a lot of prepayment penalties lately, which means that there’s an extra fee that the lender will charge you if you decide to pay off your loan early. I’ve seen that as in… Because what happens is that they… Once the loan is paid off and lenders live off the interest, they’re no longer collecting interest because you paid it off.
So sometimes they put a penalty if you pay it off sooner than later. In an ideal world, you will use your loan the length of the time. They will get as much interest as they can get out of you. Last but not least, closing costs. You got to look at the fine print on the closing costs, which have a variety of things. If it is a commercial loan, there’ll be a lot more closing costs than if it is a simple interest loan depending on the amount. The higher the amount, the higher the closing costs. So which is best? Well, we’re going to get into the pros of getting a loan. You have the ability to finance large expenditures for longer terms, which you necessarily wouldn’t have with a line of credit. You have a predictable payments. As I said before, predictability is key for a loan.
You have fixed interests. There’s an amortization schedule. You’ll know exactly how much each payment is going to principal and interest, and you have a fixed interest rate. Cons of loans. No flexibility. Once you borrow… Say you borrow $100,000 and six months later you realize you need an extra $50,000, well, you couldn’t do that. You have to apply for another loan, which you may be turned down if your financial picture has changed in your business and you’re not doing as good as you were before, or the lender may simply say, “I want to limit my exposure with you to this amount and no more.” And the payments stopped right away. Say if you get a loan for $200,000 and you don’t really have a need for it six months from now, well, you’ll be making payments from day one.
That’s something that you have to consider going in. What are the pros of a line of credit? Well, you borrow only what you need when you need it, which is big for a lot of… If businesses that are doing well cashflow wise and they’re not even really borrowing to make strategic investments like buying equipment, inventory, et cetera, they just want to have the ability to seize an opportunity when it comes. Well, if you’re doing well financially, you probably don’t need a loan. The best thing would be a line of credit. And a lot of businesses are doing well during this time and they have excess cash, I wouldn’t suggest that you need to get alone. The pros of a line credit is if you pay it down to zero, which is what the bank wants to see, you use it up and you pay it down.
You use it up and you pay down. If you keep doing that, then you’ll have a line of credit that may even get higher. They may even approve you for a larger amount. But if you get a line of credit and you keep using it to their capacity and not pay it down, it may turn into a loan. Anyway, back to pros, you have a potentially lower interest rate, but it will be variable. So cons of line of credit, shorter repayment terms. Lines of credit usually get amortized probably over 36 months or less. You have potential rate increases because of the variability of the rate, it’s not fixed, and you have unpredictable payments. One month your payment may be 3,000 and the next month, it may be 5,000. So hopefully that’s helpful to you. Please comment below and let me know if this…
If you have a line of credit, feel free to share which one would you prefer if you had a choice? Thanks again for watching this video. Please comment below and let me know which one makes the most sense for you, a business loan or a business line of credit? Also, if you want to join a community of like-minded, successful entrepreneurs just like you, then join our Facebook group at the link below where I share tips, tactics, and strategies on how my clients are growing their businesses to seven figures and beyond.
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