A client called me last month asking which is “better” – a line of credit or a term loan. Wrong question. Neither product is better. They solve different problems, and picking the wrong one is one of the more expensive mistakes a business owner can make.
If you’re weighing a line of credit vs term loan for your business, the short answer is this: a line of credit suits recurring or unpredictable cash needs, while a term loan suits a single, defined purchase you’ll pay off on a fixed schedule. The rest of this guide breaks down why, with the detail you need to make the call for your own business.
What Is a Line of Credit?
A business line of credit works like a standing pool of approved funds you can draw from whenever you need it. You’re only charged interest on the amount you’ve actually drawn, not the full approved limit. Once you repay what you’ve borrowed, that credit becomes available again – similar to a credit card, but usually with a lower rate and a business-specific credit limit tied to your turnover and trading history.
Lenders typically set the limit based on your average monthly revenue, and most facilities are reviewed annually. Some are secured against business assets or a director’s guarantee; others, particularly smaller overdraft-style facilities, are unsecured but carry a higher rate as a result.
Good fit for:
- Bridging the gap between invoicing a client and actually getting paid
- Covering seasonal stock purchases before the busy period hits
- Handling payroll during a slow month without dipping into savings
- General working capital buffer for a business with lumpy cash flow
What Is a Term Loan?
A term loan is the more familiar structure – you borrow a fixed amount upfront and repay it in scheduled instalments over an agreed period, usually with either a fixed or variable interest rate. The repayment schedule is set from day one, which makes budgeting straightforward but leaves less room to adjust if your circumstances change.
Terms typically run anywhere from one to seven years for unsecured business term loans, and longer for secured facilities tied to property or major equipment. Because the lender knows exactly what they’re funding and for how long, term loans often come with a lower interest rate than a revolving facility of similar size.
Good fit for:
- Buying a specific piece of equipment or a vehicle
- Funding a fit-out, renovation, or new premises
- Consolidating existing business debt into one repayment
- Financing an acquisition or a one-off expansion project
Line of Credit vs Term Loan: Key Differences
| Feature | Line of Credit | Term Loan |
| How funds are released | Draw as needed, up to a set limit | Lump sum, paid once |
| Interest charged on | Only the amount drawn | The full loan balance |
| Repayment structure | Flexible, minimum repayments on drawn balance | Fixed instalments over a set term |
| Best suited to | Working capital, cash flow gaps | Specific purchases or projects |
| Reusability | Revolves – repay and redraw | One-off, doesn’t reset |
| Typical rate | Often variable, can run higher | Often lower, fixed or variable |
| Approval focus | Ongoing revenue and trading history | Purpose of funds and repayment capacity |
The table above covers the mechanics, but the real decision comes down to one question: are you funding something recurring and uncertain, or something specific and known?
When a Line of Credit Makes Sense
I’ve worked with trades businesses that win a big contract, then wait ninety days for payment while still covering wages and materials every fortnight. That’s a line of credit problem, not a term loan problem – the shortfall is temporary and repeats itself with every job cycle.
Retailers heading into a seasonal peak face the same pattern. Stock needs to be paid for weeks before it sells. A line of credit lets you draw what you need for that stretch, repay it once sales come in, and leave the facility sitting there unused until the next cycle. You’re not paying interest on money you’re not using, which is the whole point of the structure.
A line of credit becomes a problem when businesses use it to plug an ongoing gap rather than a temporary one. If you’re drawing on it every single month and never getting the balance back to zero, that’s usually a sign the business needs a different kind of restructure – sometimes a term loan to consolidate, sometimes a harder look at pricing or costs.
When a Term Loan Makes Sense
A term loan fits when you know exactly what you’re spending money on and roughly how long it’ll take to pay it back. Buying a delivery van, fitting out a new café, or funding a franchise purchase are all one-off events with a clear cost. Matching that to a lump-sum loan with fixed repayments means you can build the cost straight into your budget and forecast your cash flow without guesswork.
Term loans also offer a discipline argument. Because the funds are drawn once and the repayment schedule is locked in, there’s less temptation to keep borrowing. For a business owner who’s found themselves constantly topping up a revolving facility, a term loan can actually be the more conservative choice, even though it feels like the bigger commitment upfront.
Costs and Interest Rate Considerations
Interest rates on both products move with the lender’s assessment of risk – how long you’ve traded, your revenue trend, whether the facility is secured, and your credit history all factor in. As a general rule, secured facilities (backed by property, equipment, or other business assets) attract lower rates than unsecured ones, regardless of whether you’re looking at a line of credit or a term loan.
A line of credit can look cheaper on paper because you’re only paying interest on what you draw, but it’s worth running the numbers properly. If you expect to be close to fully drawn most of the time, the effective cost can end up similar to, or higher than, a term loan for the same amount. Term loans, on the other hand, sometimes come with establishment or exit fees that need to be weighed against the certainty of a fixed schedule.
It’s also worth checking whether a facility has ongoing account-keeping fees, a redraw fee, or a minimum monthly repayment even when undrawn – these details rarely show up in headline rate comparisons but affect the real cost over a year.
How Lenders Assess Your Application
Whichever structure you’re leaning toward, lenders are looking at broadly the same things: your trading history, cash flow consistency, existing liabilities, and – for a term loan specifically – what the funds are for. Most lenders want at least six months of trading history and recent business bank statements before they’ll consider an application, and established businesses are usually asked for tax returns and profit and loss statements as well.
Working across a panel that includes ANZ, Westpac, NAB, Commonwealth Bank, Macquarie, Resimac, AMP, Bank of Sydney, Pepper Money, and AMFIN gives a clearer picture of which lender actually suits a given situation, because risk appetite varies more than most business owners expect. A bank that declines an unsecured line of credit application might approve the same business for a secured term loan, or vice versa, depending on how they weigh the numbers.
Common Mistakes Business Owners Make
The most common one I see is matching the wrong product to the need – taking out a term loan for working capital, then finding the fixed repayments don’t flex when a slow month hits. The reverse happens too: using a revolving line of credit to fund a big one-off purchase, then carrying a large drawn balance indefinitely because there was never a real repayment plan behind it.
Another mistake is not shopping the application across more than one lender. Rates and serviceability criteria differ enough between banks that the same business can be offered meaningfully different terms depending on who’s assessing the file.
Getting the Right Structure for Your Business
There’s rarely a single correct answer here – plenty of businesses end up using both, a line of credit for the day-to-day cash flow bumps and a term loan for the bigger, planned purchases. What matters is being honest about which category your funding need falls into before you apply, because that decision shapes everything from the interest rate you’re offered to how much flexibility you have if things change.
At Ace Finance Solutions, we work through this with business owners across Melbourne and nationally, matching the funding structure to what the business actually needs rather than what’s easiest to sell. If you’re not sure whether a line of credit vs term loan is the right call for your situation, book a free consultation and we’ll walk through the numbers with you.
Frequently Asked Questions
Can I have both a line of credit and a term loan at the same time?
Yes. Many businesses run both – a line of credit for working capital and a term loan for a specific asset or project. Lenders will factor both facilities into your overall serviceability assessment.
Is a line of credit harder to get approved than a term loan?
Not necessarily harder, but the assessment focuses more heavily on your ongoing revenue and cash flow consistency, since the lender is extending an open facility rather than funding a defined purchase.
Which option has a lower interest rate, a line of credit or a term loan?
It depends on the lender, whether the facility is secured, and how much of the line of credit you typically draw. Term loans are often quoted at a lower headline rate, but a lightly used line of credit can end up cheaper overall.
Do I need security to get a business term loan?
Not always. Unsecured term loans are available, usually for smaller amounts and shorter terms, while larger or longer-term facilities are more commonly secured against property or business assets.
How much trading history do I need to apply?
Most lenders want at least six months of trading history and recent bank statements. Newer businesses have fewer options but can still qualify with some lenders, particularly for smaller facilities.
