Choose a line of credit when the need is recurring or its size is uncertain, like payroll gaps or seasonal inventory. Choose a term loan when you need a known amount once, like an expansion, and want fixed payments. A line charges interest only on what you draw. A term loan charges interest on the full amount from day one.
That one difference in how interest accrues drives almost everything else: cost, flexibility, and which mistakes are expensive.
What is the difference between a line of credit and a term loan?
A business line of credit is a revolving limit. You draw what you need, repay it, and draw again without reapplying. A term loan is a lump sum deposited once and repaid on a fixed schedule until the balance hits zero.
| Line of credit | Term loan | |
|---|---|---|
| How you receive money | Draw any amount up to your limit, whenever you need it | One lump sum at closing |
| Interest charged on | Only the amount currently drawn | The full loan balance from day one |
| Payments | Vary with your balance | Fixed, same amount each period |
| Reusable | Yes, repaid amounts become available again | No, you reapply for more |
| Rate type | Often variable | Usually fixed |
| Best for | Recurring gaps, uneven cash flow, safety net | One-time investments with a known price |
| Sagamore partner range | $5K to $500K | $10K to $2M, terms of 6 to 60 months |
Which costs less: a line of credit or a term loan?
It depends on how much of the money you actually use, and for how long. Here is a hypothetical example with the same illustrative rate on both products, so the only variable is structure. These are not quotes; real rates depend on your profile and the lender.
Say a specialty food distributor expects to need up to $60,000 over the next year to cover gaps between paying suppliers and getting paid by grocery chains. Most months it only needs part of that. Its average outstanding balance works out to about $25,000.
Option 1: $60,000 term loan, 12 months, 15% annual rate (illustrative)
- Monthly payment: about $5,416
- Total repaid: about $64,990
- Interest paid: about $4,990
The distributor pays interest on the full $60,000 even in months when half of it sits idle in the bank account.
Option 2: $60,000 line of credit, 15% annual rate (illustrative), average balance $25,000
- Interest: $25,000 × 15% = about $3,750 for the year
The line saves roughly $1,240 because interest follows the actual balance. The gap widens the more lopsided the usage is. If the average balance were $15,000, line interest would drop to about $2,250.
When the math flips
Now say the distributor needs the full $60,000 on day one to buy a refrigerated delivery van. The balance will be near the limit for months. The line's advantage disappears, and several disadvantages show up:
- Line rates are often variable, so the cost can rise mid-year. A fixed term loan locks the cost in.
- Some lines carry draw fees, annual fees, or require each draw to be repaid on its own short schedule. Ask how draws are repaid before assuming interest-only flexibility.
- A maxed-out line leaves no room for the next surprise, which defeats the reason for having one.
For a fully used, one-time amount, the term loan is usually the cleaner and more predictable choice. For a vehicle or machine specifically, equipment financing may beat both, since the asset itself secures the loan.
When is a line of credit the better choice?
A line fits when you can't name the exact amount or date you'll need the money. Typical hypothetical fits:
- A commercial cleaning company whose clients pay on net-45 while payroll runs every two weeks. It draws $15,000 to $30,000 a few times a quarter and repays as invoices clear.
- A retailer that stocks up before its busy season, then pays the line down as inventory sells.
- A contractor who wants a standing cushion for a surprise repair or a materials deal that won't wait.
The common thread is repayment from ordinary revenue within a few months. The line is a shock absorber, not a source of long-term capital.
When is a term loan the better choice?
A term loan fits when the need has a price tag and the payoff arrives over years:
- Opening a second location with a $180,000 build-out budget.
- Hiring a team whose added revenue ramps up over 12 to 24 months.
- Consolidating several expensive short-term balances into one fixed payment.
Fixed payments make the loan easy to budget, and the full cost is known before you sign. If the expense is large and you can wait several weeks, an SBA loan may offer a longer term, at the cost of a slower and more involved process.
What goes wrong when you pick the wrong one?
The costly mistake is a mismatch between how long the money is useful and how long you take to repay it.
| Mistake | What happens |
|---|---|
| Using a line for a long-lived purchase | The balance stays high for years, the line is unavailable for real emergencies, and variable rates add risk |
| Using a term loan for a recurring gap | You pay interest on cash that sits unused, then need another loan when the next gap comes |
| Using either for a gap with a single known end date | A bridge loan may be better, since it's built around a specific repayment event |
A simple rule: match the repayment period to how long the money keeps producing value. Payroll float pays off in weeks, so it belongs on a line. A new location pays off over years, so it belongs on a term loan.
Do lenders qualify you differently for each?
The baseline is similar. Sagamore's lending partners generally look for at least 4 months in business, $5,000 or more in monthly deposits, and a credit score of 500 or higher for both products. Stronger profiles get larger amounts and better pricing.
The differences show up at the margins:
- Line size is usually tied to monthly revenue, since the lender expects the balance to be repaid from ordinary cash flow.
- Term loan size can go higher, but larger amounts may require tax returns or financial statements in addition to bank statements.
- Ongoing review applies to lines. A lender can reduce or freeze a line if your deposits fall or your credit changes. A funded term loan can't be pulled back as long as you make your payments.
Both products commonly involve a personal guarantee and a UCC lien on business assets. Read those terms as carefully as the rate.
Can you have both a line of credit and a term loan?
Yes, and many established businesses do. A common hypothetical setup: a $250,000 term loan funds an expansion, and a $50,000 line covers the uneven months while the new location ramps up. The term loan handles the planned spend. The line handles the unplanned.
Lenders will look at your total debt payments against your cash flow before approving the second facility. If you know you'll want both, it's often easier to arrange them together or get the line first, while your balance sheet is lighter.
How do you decide? Five questions
- Do you know the exact amount you need? Yes points to a term loan. No points to a line.
- Is the need one-time or recurring? One-time: term loan. Recurring: line.
- Will you use most of the money right away? If yes, the line's interest advantage mostly disappears.
- How long until the spending pays for itself? Weeks or months: line. Years: term loan.
- Would a variable payment strain your budget? If yes, lean toward the fixed payments of a term loan.
If your answers split, that's often a sign you need both, or a different product entirely.
Sagamore is a broker, not a lender, so we can show you what lenders offer on both structures side by side for the same application. If you'd like to compare real offers against your numbers, you can start an application in about five minutes.
