A term loan gives you a lump sum repaid on a fixed schedule — right for one-time investments with a long life. A line of credit is a revolving limit you draw and repay as needed, paying interest only on what you use — right for recurring, temporary gaps. Match the term of the money to the life of the need.
There is one principle underneath every good financing decision, and almost every bad one violates it: match the term of the money to the life of the need.
Long-term asset, long-term money. Short-term gap, short-term money. Get this backwards in either direction and you pay for it — sometimes for years.
The two instruments
| Term loan | Line of credit | |
|---|---|---|
| Structure | Lump sum up front | Revolving limit you draw against |
| Interest | On the full balance from day one | Only on what you have drawn |
| Repayment | Fixed schedule, usually monthly | Flexible; repay and redraw |
| Best for | One-time investments with lasting value | Recurring, temporary gaps |
| Cost when idle | You pay whether or not you needed it | Often just a modest unused-line or annual fee |
| Risk | Borrowing more than you needed | Never repaying it — letting it become permanent debt |
Use a term loan when the need has a long life
Buying a building. Acquiring a competitor. Purchasing a machine that will run for fifteen years. Refinancing expensive short-term debt into something survivable.
These share a shape: a large one-time outlay producing value over years. Repaying it over years matches the value to the cost. Nobody should pay for a fifteen-year machine out of ninety days of cash flow.
For asset purchases specifically, look at equipment financing before generic term debt — it is secured by the asset, so it usually prices better. And for the largest and longest needs, SBA 7(a) or 504 terms are typically the best a small business can access.
Use a line of credit when the need keeps coming back
Payroll in a slow month. Inventory before a busy season. Bridging the 45 days between finishing a job and getting paid for it.
These are not one-time problems. They are the permanent rhythm of your business. A term loan is an awful fit: you would borrow a lump sum, pay interest on all of it continuously, and still face the same gap next quarter.
A line handles it correctly. Draw $40,000 in the slow month. Repay it when the receivables land. Pay interest on $40,000 for six weeks, not on $200,000 for five years. Then draw again next time.
A typical gap between delivering work and collecting payment. That gap is permanent and recurring — which is exactly why it should be financed with a revolving instrument, not a term loan. See the cash conversion cycle.
The line of credit failure mode
There is one, and it is serious: the line that never gets repaid.
You draw $50,000 for a slow month. Business picks up, but the money goes into inventory and payroll instead of paying the line down. Next slow month you draw more. The balance ratchets up and never returns to zero.
Your line has silently become a permanent term loan — at a revolving rate, with no amortization schedule forcing you to retire it, and often with an annual review that can reduce or pull the limit at the worst possible moment.
A healthy line touches zero at some point in the year. If yours has not been at zero in eighteen months, you do not have a working capital line; you have undiagnosed term debt, and probably a structural problem your cash conversion cycle would explain.
The mismatches that cost the most
Short-term money for a long-term asset. Financing a building with a one-year balloon. It works right up until the balloon comes due and the refinance market has moved. This is the structure that destroys otherwise-sound businesses in a downturn.
Long-term money for a short-term gap. Taking a five-year term loan to cover a seasonal dip. You now carry a payment for four more years after the need evaporated.
Very short-term money for anything at all. Using a merchant cash advance — effectively 3–9 month money at triple-digit effective APR — for a need with any longer horizon. The daily debit begins immediately, so it hits your cash flow before the thing you bought has produced anything.
What each of these is actually like to get
Some financing is simply easier to get
Share of applicants fully approved, by product.
Equipment paper is the easiest full approval in small-business finance, because the equipment secures the loan. Note the Federal Reserve reports this for equipment loans and does not break out leases — do not read the 71% as a leasing number. The SBCS is not a random sample; the Federal Reserve advises reading it with awareness of convenience-sample bias.
View the data as a table
| Value | |
|---|---|
| Auto or equipment loan | 71% |
| Mortgage | 55% |
| Merchant cash advance | 48% |
| Business line of credit | 45% |
| Personal loan | 40% |
| Business loan | 37% |
Two things to take from this. A business line of credit is approved in full for fewer than half of applicants, and a general business loan for fewer still — so neither instrument is something to assume you have until you have it, which is the entire argument for arranging the line early. And note where the secured products sit: auto and equipment loans clear at a rate nothing unsecured comes close to. If the need is an asset, financing it as an asset is not just cheaper, it is likelier to happen at all. The Fed cautions that this is not a random sample, so treat the ordering as the signal rather than the individual percentages.
Get the line before you need it
This bears repeating because it is the highest-leverage move in the entire article.
Lines of credit are approved on strength. Apply when your last two quarters look good, your statements are clean, and you do not need the money, and you will get a limit and a rate that would be unobtainable during the week you are desperate.
An unused line generally costs little — often a modest annual or unused-line fee. That is insurance pricing for a fundamentally different relationship with bad news. When the slow month comes, you draw. You do not shop for emergency money, which is the most expensive shopping there is.
Questions before you sign either
- What is the true all-in cost? Rate plus origination plus fees plus any unused-line fee. Ask for the total dollars.
- Is the rate fixed or variable, and if variable, tied to what index?
- Prepayment penalty? On a term loan this decides whether a good year can actually clear the debt.
- For a line: is it committed or demand? A demand line can be reduced or called at the lender's discretion — frequently exactly when conditions turn and you need it most. This is the single most under-asked question in small business lending.
- What are the covenants? Ratios you must maintain, reporting you must deliver. Breaching a covenant you never read can trigger a default on a loan you are paying perfectly.
- Personal guarantee terms — capped, released after a period, or unlimited? See personal guarantees.
- Does it report to business bureaus? A well-handled line is an excellent trade line — if reported.
We help businesses figure out which instrument the situation actually calls for — including, regularly, "neither, and here is the operational fix instead." See business lending.
Questions business owners actually ask
What is the difference between a term loan and a line of credit?
A term loan is a lump sum repaid on a fixed schedule, with interest accruing on the full balance from day one. A line of credit is a revolving limit you draw and repay repeatedly, with interest charged only on the drawn amount. Term loans suit one-time long-lived investments; lines suit recurring temporary gaps.
Should my line of credit ever be at zero?
Yes. A healthy working capital line touches zero at some point during the year. A line that has carried a balance continuously for over a year has effectively become permanent term debt at a revolving rate, usually signalling a structural cash flow problem rather than a temporary gap.
What is a demand line of credit?
A line the lender can reduce or call at its discretion, rather than one committed for a defined term. The risk is that it can be pulled precisely when conditions deteriorate and you need it most. Always ask whether a line is committed or demand before you rely on it.
Is it cheaper to get a line of credit before I need it?
Almost always. Approval and pricing depend on how strong your financials look at application. Applying during a good stretch, when you do not need the funds, produces a better limit and rate than applying in a crisis. An unused line typically costs only a modest fee to maintain.
Sources
Every figure in this article is traceable to a primary source. Rules and rates change — verify against these before acting.
Important: MidBank is not a bank, a financial institution, or a financial advisor. We are an advocate and ISO affiliate that connects businesses to vetted third-party providers. This article is general information published on July 14, 2026, not legal, tax, or financial advice — rules and rates change, and your situation is specific to you. Confirm details with the primary sources linked above and with a qualified tax or legal professional before acting.
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