Small Business Loans: Installment versus Revolving Options
September 21, 2022 | Last Updated on: January 31, 2023
September 21, 2022 | Last Updated on: January 31, 2023
Small business installment and revolving credit loans serve very different purposes. Both can provide benefits to businesses that need financing. However, if either of these types of small business loans is used for the wrong purposes, there could be significant consequences. This article explains what you need to know to use installment and revolving forms of credit correctly.
Installment loans provide a lump sum of money that’s paid back at regular intervals with interest through fixed payments over a defined repayment period, referred to as the term. Typically, each payment includes money to pay back the principal balance (the amount borrowed) plus some money to pay interest.
This financing type is often referred to as a term loan because a key part of the loan agreement is the term, or time it needs to be paid back. Short-term loans are typically paid back in a year or less. Some long-term loans, such as ones to finance business property purchases, come with terms of up to 30 years
After an installment or term loan is paid off, the borrower typically applies for a new loan if additional funding is needed.
Revolving credit provides small business owners with more flexible funding than installment loans.
A revolving loan is a credit agreement that allows borrowers to use loan money as needed up to a preset limit they are approved to borrow. The borrower then repays the lender a portion of the balance at regular intervals. Each payment is based on the current balance, interest charges, and applicable fees. The borrower pays interest only on the borrowed funds, not the maximum loan amount they’re approved for.
A business line of credit is a common form of revolving credit. It works like a credit line you’d take out on your home. Another example is a business credit card.
Revolving credit provides the borrower with flexibility when it comes to using the funding and how much of it they use. As long as the credit balance remains within the preset limit and you continue to make timely payments, you can draw from the revolving credit line over time.
In the case of revolving credit, the only time a business owner needs to reapply is if they want to increase the amount of funding they are allowed to borrow.
The simplest way to understand the differences between installment loans and revolving credit is through direct comparison.
Installment loan: You are approved for a fixed amount of financing.
Revolving line of credit: You are approved for a maximum amount you can borrow against.
Installment loan: You receive a single, one-time lump-sum payment.
Revolving line of credit: You can access funding on an as-needed basis.
Installment loan: You pay back a regular fixed amount.
Revolving line of credit: You must pay a minimum amount or more (at your discretion) based on the money borrowed and interest owed.
Installment loan: Monthly installment payments or more frequently.
Revolving line of credit: Typically, monthly.
Installment loan: Interest is based on the total amount of the loan.
Revolving line of credit: Interest is based on the amount of approved funding used, not the maximum amount of funding approved.
Installment loan: Typically, not able to be renewed. Must apply for new funding once the loan is paid back.
Revolving line of credit: Typically, ongoing funding, which makes it renewable. You can always apply for a higher maximum approved borrowing limit.
Here are some different times when it makes sense to get an installment loan:
If you know the total amount of money you need to borrow, then an installment loan could be right for you, especially if you need the money in a lump sum. If you need funds to make a one-time purchase or deal with a single issue, you’ll likely want this type of financing. For instance, if you’re purchasing an expensive piece of business equipment, you likely want to take out an equipment loan, a form of installment financing.
Term loans typically give you more time for repayment when compared with revolving credit. When you make payments over a more extended period, it usually results in lower monthly payments. However, that usually means you’ll pay more in interest over the life of the loan.
If you want to purchase property, equipment, or other costly items, there are different types of installment loans that can be used for these purposes. Short-term loans are better for loans on the “smaller” end of the large-funding-needs spectrum (example: communications equipment). In comparison, long-term loans are better for very large purchases (example: business property or vehicles.) Revolving credit limits are often much lower than term loan amounts.
With a set monthly payment amount, it can be easier for small business owners to budget for an installment loan compared with a revolving loan. Revolving loan payments vary depending on how much of the approved funding you borrow against.
Most installment loans come with fixed interest rates. That’s not the case with many revolving loan types, especially credit cards, which often have variable interest rates. It takes some of the doubt away from getting a loan, especially during this time of rising interest rates.
Revolving credit is good for handling short-term cash emergencies or paying for unexpected expenses. Some businesses use lines of credit as an emergency fund.
Businesses that experience fluctuations in their cash flow could benefit from having a revolving line of credit. Seasonal industries like nurseries that don’t earn consistent revenue throughout the year can use lines of credit for working capital and to cover operational costs during their slow periods.
Most installment financing types are secured loans, which means you have to put up business or personal assets as collateral. Many small business owners are uncomfortable with this, making installment loans more appealing.
It’s a good idea to make business purchases with a business credit card. It makes it easier to track them against personal expenses. This is particularly important at tax time.
You should make it a point to pay back your credit cards quickly to avoid paying interest on regular business purchases. Also, use credit cards that provide perks that benefit your business, such as cashback or travel benefits.
If you don’t know exactly how much financing you need, revolving credit will allow you to qualify for a maximum amount but only use loan money on an as-needed basis.
There are installment loan options for all types of business funding needs.
A short term loan provides a small business with a lump sum of capital, which gets paid back over a defined time (typically within a year) with an agreed-upon payment schedule. These loans usually come with the lowest interest rates and most favorable repayment terms of all the business financing options.
One issue is that you need a solid credit score to qualify for a short-term loan. (Business owners with bad credit typically don’t get approved.) You might also be required to put up some personal or business assets as collateral for these loans. The application process — along with the approval process — through traditional lending institutions can take a month or more. You may be able to speed this up by applying for a term loan through an online lender like Biz2Credit. You complete a digital application, including uploading financial statements, tax returns, a business plan, a balance sheet, and other documents, as needed to determine eligibility. In many cases, you could be approved in as little as one day and get the funding deposited into your business bank account the next day.
Long-term loans are similar to short-term ones, except they come with a longer term length, from several years to decades. They also typically come with higher interest rates. Application and approval processes for long-term loans can be lengthy and rigorous. You need good credit to be approved. (Lenders will pull a credit report to check your credit score.) In many cases, whatever the loan money is used to purchase, for instance, an expensive piece of machinery, business property, or a vehicle is used to collateralize the loan. If you use it for other purposes, for instance, to acquire another business, you may need to put up personal or business assets to back the loan.
A real estate loan is a long-term loan used to purchase business property, such as a shop, office, or warehouse. This type of loan can come with terms of up to 30 years, and the property the loan money is used to purchase backs the loan. Interest rates are relatively low for these loans, but the interest paid on them can add up over time.
If you need to purchase a piece of equipment, such as a computer, manufacturing machine, or refrigeration unit, equipment loans could be a great solution. No down payment or upfront cash is required, and the equipment you purchase serves as collateral for the loan, reducing the interest you pay. You don’t need to put up personal assets to qualify for equipment loans and getting approved is relatively simple.
The Small Business Administration offers many types of installment loans, including its popular SBA 7(a) loan program, through SBA-approved lenders. SBA loans are very popular because the financing comes with a partial government guarantee and relatively low interest rates. It can take a month or more to get approved for these highly favorable loans, and only established businesses with excellent credit histories qualify. However, if you can get approved, these could be the best installment loans for your business.
A business line of credit could be a good option if your company has regular emergency cash needs. It’s suitable for organizations that want on-demand access to funds, at a competitive interest rate, with reasonable repayment terms. A loan issuer approves you for a revolving line of credit, similar to a credit card. You don’t use the funding until you need it, and you only pay back your credit line when you’ve accessed it. You can use a business credit line for virtually any emergency cash or other business needs.
To qualify for a business credit line, you must have solid credit scores, a well-established personal credit history, and access to a significant amount of available credit that you haven’t used. A business line of credit has a much more rigorous approval process than a business credit card. A line of credit also has lower interest rates and comes with no cash advance charges.
Business credit cards are a smart way to pay for regular, everyday business expenses. It allows you to separate business expenses from personal ones. Make it a point to pay the entire balance every month. It will help you keep interest payments in check and maintain an ongoing approved balance to borrow from.
Installment and revolving loans are both useful for businesses. What’s important is that you leverage the correct type of financing for your needs. If you’re still unclear, contact a loan expert at Biz2Credit who can help explore your options with you.