Understanding the difference between installment and revolving credit is crucial for small business owners considering financing options. When it comes to acquiring a small business loan, the decision between an installment or revolving credit can significantly impact cash flow management, repayment terms, and the overall cost of borrowing. The right choice supports business sustainability and growth, making it essential for entrepreneurs to grasp the nuances of each option.
This article will explore the distinctions between installment loans and revolving credit, highlighting the pros and cons of each to aid small business owners in making informed decisions. The sections will cover the fundamentals of installment loans, delve into the advantages and disadvantages, and do the same for revolving credit. Further, it will assist in choosing between the two, providing a comprehensive understanding of when a small business loan installment or revolving credit might be more beneficial for a business’s financial needs, whether it’s a small business loan from a bank, installment loans, or revolving credit.
Installment Loans Explained
How Installment Loans Work
An installment loan is a type of financing where the borrower receives a lump sum of money that is repaid at regular intervals over a predetermined period [1][2]. These payments are typically made monthly and include a portion for interest alongside the principal amount [1]. This structure provides a predictable repayment schedule and a fixed end date for when the loan will be fully paid off [2]. A small business installment loan is a common type of business term loan.
Eligibility and Application Process
To qualify for an installment loan, lenders evaluate several factors including the borrower’s creditworthiness, the amount of time the business has been operational, and its revenue [3]. Businesses often need to have been in operation for several years and have a substantial annual revenue to be considered [4]. Additionally, providing collateral might be necessary, especially for secured loans, which could include assets like real estate or equipment [1]. Unsecured loans may also be available, though they often come with higher interest rates.
Typical Loan Amounts and Terms
The amount of an installment loan can vary significantly, generally starting around $50,000 and extending beyond $1 million, depending on the lender and the borrower’s qualifications [5]. Terms for these loans can range from short-term options of 3 to 24 months, up to longer terms of up to 10 years [5]. The interest rates are influenced by several factors including the type of lender, such as banks or online lenders, the loan amount, and the borrower’s credit profile [5].
Pros and Cons of Installment Loans
Advantages
- Larger Funding Amounts: Installment loans typically provide larger upfront sums, which are beneficial for covering significant one-time business expenses or capital investments [6].
- Predictable Payments: These loans offer a set payment schedule with fixed monthly payments, making it easier for businesses to budget and plan financially [6][7].
- Longer Repayment Terms: With the option of extended repayment periods, businesses can experience reduced monthly payment pressures [6][7].
- Potential for Lower Interest Rates: Compared to other short-term financing options like payday loans, installment loans may offer lower interest rates, resulting in cost savings over time [6].
- Credit Building: Regular, on-time payments can help improve a business’s credit score, enhancing their ability to secure future financing [7].
Disadvantages
- Rigid Repayment Terms: The fixed repayment schedule may not align well with businesses that experience fluctuating cash flow or seasonal fluctuations, potentially making it challenging to meet payment deadlines consistently [6][2].
- Higher Interest Rates Compared to Variable Options: Sometimes, the fixed rates of installment loans can be higher than those of variable-rate loans, leading to higher overall interest costs [6].
- Limited Flexibility for Ongoing Needs: Once the lump sum is provided, there is no flexibility to borrow more without undergoing another loan application process [6].
- Collateral Requirements: Some installment loans require collateral, posing a risk to business assets if the loan cannot be repaid [6].
- Prepayment Penalties: Certain loans may penalize businesses for early repayment, limiting the flexibility to manage debt more aggressively [6][7].
Revolving Credit Explained
Revolving credit offers a flexible financing solution for small businesses, functioning similarly to a business credit card but designed to meet broader business needs. This type of credit allows businesses to draw funds up to a predetermined limit, use the money for various expenses, and then replenish the funds as they are repaid.
How Revolving Credit Works
A business line of credit provides accessible funds that businesses can use repeatedly without reapplying, as long as the account remains in good standing. The principal amount repaid becomes available again, offering continuous access to capital [8][9][10][11]. This cycle of borrowing and repayment, which characterizes revolving credit, supports businesses in managing cash flow efficiently by providing flexible funding on an as-needed basis [8][9][10][11].
Eligibility and Application Process
To qualify for a revolving line of credit, businesses typically need to meet certain criteria such as having a minimum credit score, a proven track record of at least 6-12 months, and a certain level of annual revenue [9][10]. The application process usually involves submitting financial documents like tax returns, business financial statements, and credit references, which lenders review to determine creditworthiness and set a credit limit [9].
Typical Credit Lines and Terms
Revolving credit lines can range from $10,000 to $250,000, with some lines requiring collateral if they exceed certain amounts. Interest rates on these credit lines are generally lower than those on business credit cards, making them a more cost-effective option for ongoing financial needs [8][9][10][11]. The flexibility of drawing and repaying funds according to business needs, without the need for reapplication, makes revolving credit a practical tool for businesses looking to manage their cash flow dynamically [8][9][10][11].
Pros and Cons of Revolving Credit
Advantages
- Immediate Access to Funds: Revolving credit lines provide business owners with the ability to draw only the amount of capital they need, which can then be replaced and become immediately available again [12].
- Flexibility for Unexpected Needs: These credit lines are particularly useful for managing unexpected business challenges and opportunities, offering fast and accessible funding [12].
- Lower Interest Rates: Typically, revolving credit lines have lower true interest rate APRs compared to other funding products like merchant cash advances (MCAs) [12].
- No Collateral Required: Many revolving credit lines are unsecured, meaning no real estate or other assets need to be leveraged as collateral [12].
- No Prepayment Penalties: Business owners can pay down or pay off their credit lines at any time without penalty, providing greater control over debt management [12].
- Control Over Borrowing: Owners have the peace of mind of borrowing exactly what they need, avoiding the risk of over-borrowing [12].
- Credit Building: Utilizing and repaying revolving credit can help in building a business’s FICO score, and enhancing creditworthiness [12].
- Potential for Credit Line Growth: As the business grows, revolving credit lines can be reviewed and potentially increased, aligning with the business’s expanding needs [12].
Disadvantages
- Limited Borrowing Capacity: Initially, revolving business lines of credit may have lower credit limits compared to other loan types, though these can increase with timely repayments [13].
- Higher Interest Rates Compared to Other Loans: Despite higher rates compared to credit cards, revolving lines can still carry higher rates than some other types of loans due to their flexibility and risk to lenders [13][14].
- Commitment Fees: Some lines of credit require commitment fees, which are charged regardless of whether the funds are used, potentially increasing the cost of borrowing [14].
- Lower Loan Amounts for Fluid Needs: The flexibility of revolving lines often means approved amounts are lower than those for traditional loans, which might not meet substantial financing needs [14].
Choosing Between Installment Loans and Revolving Credit
Assessing Your Business Needs
When determining whether to opt for an installment loan or revolving credit, it’s crucial to consider the specific financial needs of your business. An installment loan might be suitable if the business requires a substantial sum for a one-time purchase or investment. For instance, acquiring new equipment or property often necessitates a large upfront payment, making installment loans a practical option due to their large loan amounts and fixed repayment schedules [1]. Conversely, if a business requires flexibility for ongoing expenses or faces uncertain cash flow, revolving credit provides the ability to draw funds as needed, which can be particularly beneficial during fluctuating market conditions [1].
Case Studies and Examples
Several case studies highlight how different types of loans support business success. For example, Salt & Straw utilized a traditional bank installment loan to establish their ice cream shop, which allowed them to expand to 19 locations across the U.S. [15]. Similarly, JH Greene & Son leveraged an SBA installment loan to scale their operations by taking on larger projects [15]. On the other hand, LuminAid’s success with an online loan facilitated its product launch and subsequent expansion [15]. Each case underscores the importance of choosing the right type of loan based on the specific goals and circumstances of the business.
Final Considerations
It’s also essential to evaluate the terms and conditions associated with each type of financing. Installment loans often have fixed interest rates, providing predictability in budgeting, but may come with rigid repayment terms that could pose challenges for businesses with variable income [1]. Revolving credit offers flexibility with its draw-as-needed feature, which can be advantageous for managing short-term financial gaps or unexpected expenses. However, it typically involves variable interest rates, which might increase the cost of borrowing over time [1]. Deciding between these options requires a balanced consideration of immediate needs and the long-term financial health of the business.
Conclusion
Navigating the landscape of small business financing requires a nuanced understanding of the diverse options available, including the strategic deployment of installment loans and revolving credit. Throughout this discussion, we’ve underscored the critical distinctions between these two types of credit, spotlighting their respective advantages and disadvantages. By examining their unique attributes, we’ve provided a foundation for small business owners to make informed decisions that align with their financial needs, goals, and the operational dynamics of their enterprises. Whether the pursuit is for fixed, long-term financing for substantial one-off investments or flexible credit for fluctuating cash flow and unexpected expenses, the choice between installment loans and revolving credit is pivotal.
The decision-making process, enriched by case studies and comprehensive analysis, highlights the importance of matching the choice of financing with the strategic objectives and financial health of the business. It’s not merely about selecting a financing option but choosing a partner in growth and sustainability. As small business owners weigh their options, considering not only the immediate impact but also the long-term implications for their financial health is crucial. Further exploration and consultation may be necessary to navigate this complex decision-making landscape, ensuring that the chosen path of financing concretely supports the business in achieving its objectives while fostering growth and stability in an ever-evolving market landscape.
FAQs
1. Can a small business loan be classified as installment or revolving?
A small business loan can either be an installment loan or a revolving loan. These two types of loans differ significantly in terms of how funds are disbursed and their optimal uses.
2. Do SBA loans offer revolving credit options?
While many SBA loans are structured as installment loans, such as the 7(a) loans and microloans, the SBA does provide revolving lines of credit through programs like SBA Express, Export Express, Export Working Capital, and CAPLines.
3. Do small business loans come with fixed or variable interest rates?
Small business loans can have either fixed or variable interest rates. A fixed-rate loan maintains the same interest rate and monthly payment throughout the life of the loan, which aids in budgeting for repayments.
4. What defines a revolving loan in a business context?
A revolving loan, or line of credit, allows a business to borrow money on an as-needed basis to cover working capital requirements and sustain operations. This type of financing is particularly useful during periods of fluctuating revenue, enabling the business to manage bills and unforeseen expenses by drawing on the loan.
References
[1] – https://www.nerdwallet.com/article/small-business/small-business-loan-installment-or-revolving
[2] – https://www.unitedcapitalsource.com/blog/installment-or-revolving-credit/
[3] – https://paymentcloudinc.com/blog/business-loan-requirements/
[4] – https://www.forbes.com/advisor/business-loans/how-to-get-a-business-loan/
[5] – https://www.sofi.com/learn/content/business-loan-terms/
[6] – https://www.ondeck.com/resources/is-small-business-loan-installment-or-revolving
[7] – https://www.rok.biz/blog/risk-management-strategies-assessing-the-pros-and-cons-of-installment-vs-revolving-small-business-loans/
[8] – https://business.bankofamerica.com/resources/understanding-business-lines-of-credit.html
[9] – https://www.rapidfinance.com/blog/a-small-business-revolving-line-of-credit/
[10] – https://www.nationalbusinesscapital.com/blog/what-is-a-revolving-business-line-of-credit-and-how-does-it-work/
[11] – https://www.investopedia.com/terms/r/revolvingcredit.asp
[12] – https://www.nationalbusinesscapital.com/blog/top-9-benefits-of-revolving-business-lines-of-credit/
[13] – https://metrocommunitydevelopment.com/business-lines-of-credit/
[14] – https://www.forafinancial.com/blog/working-capital/pros-cons-revolving-line-credit/
[15] – https://fastercapital.com/topics/case-studies-of-successful-small-business-loans.html
