Getting financing for your small business can be confusing, especially when it comes to understanding the difference between installment and revolving loans. Small business loans come in many forms, but most fall into one of these two categories. Knowing the key features of installment and revolving loans can help you pick the best option to fund your business needs.
What are Small Business Loans?
Small business loans provide funding to entrepreneurs and small business owners who need capital. The funds can be used for a variety of business purposes like:
- Buying equipment or machinery
- Expanding facilities or operations
- Hiring more staff
- Marketing and advertising
- Managing cash flow
Small business lending options range from short-term loans of under 12 months to long-term loans of up to 25 years. Loan amounts often range from $5,000 to $5 million, but can be higher or lower depending on the lender.
To qualify for a traditional small business loan, you’ll likely need good personal credit, some collateral, and a solid business plan. Newer online lenders may have less stringent requirements.
Installment Loans
Installment loans provide the borrower with a lump sum of cash upfront and are repaid over time in fixed payments on a set schedule. These loans have fixed interest rates, terms, and monthly payments.
Some common types of installment financing used by small businesses include:
SBA Loans
Small Business Administration (SBA) loans are government-backed loans offered through certified lenders like banks and credit unions. The SBA guarantees a portion of the loan, helping entrepreneurs qualify who might not otherwise.
SBA 7(a) and 504 loans are popular installment loan programs with low down payments, competitive rates, and long repayment terms. Loan amounts for 7(a) loans range from $5,000 to $5 million.
Term Loans
Term loans are installment loans issued by banks, credit unions, or online lenders that provide a lump sum upfront and are repaid over 12-60 months. Terms of 1-5 years are common. These loans have fixed monthly payments, rates, and terms over the life of the loan.
Term loans can be secured or unsecured. Secured loans require collateral like equipment, real estate, or investments. Unsecured loans have higher rates but don’t require collateral.
Equipment Financing
Equipment financing offers fixed installment loans specifically for purchasing machinery, vehicles, or other equipment. Payments are made monthly over the set repayment term. Some types of equipment financing include:
- Equipment loans - For purchasing equipment with fixed terms of 1-5 years usually. The equipment acts as collateral.
- Leasing - Similar to renting equipment for business use long-term. Flexible end-of-lease options to buy, return, or re-lease the equipment.
- Vehicle loans - For purchasing cars, trucks, or other vehicles needed for the business.
Real Estate & Mortgage Loans
Longer-term real estate installment loans can provide financing to purchase or refinance land, buildings, and other property that is used for your small business.
- Commercial mortgages come with 10-25 year terms, larger loan amounts, and lower rates than other financing options. The real estate purchased acts as collateral.
- Commercial construction loans provide funding in phases to build new facilities for your business. They convert to commercial mortgages once construction is complete.
Revolving Loans
Revolving loans provide flexible borrowing up to a set limit. You can draw down funds as needed and make monthly payments based on your outstanding balance, not a fixed amount. These lines of credit are renewable, allowing you to borrow, repay, and borrow again over the course of the agreement.
Common revolving loan options for small businesses include:
Business Credit Cards
Business credit cards let you pay for purchases and other expenses, then make monthly payments toward the balance. Interest rates are usually variable. Credit limits range from a few thousand dollars up to over $100,000 depending on the card and your qualifications.
Business Lines of Credit
Business lines of credit (LOC) provide access to a revolving credit pool. You can draw down funds as needed up to your credit limit. Interest rates are variable or fixed. LOC terms range from 1-5 years usually.
LOCs are flexible, renewable credit similar to credit cards. They often offer higher limits and lower rates than cards tailored for business use.
Merchant Cash Advances
A merchant cash advance (MCA) provides a lump sum in exchange for an agreed upon percentage of your future credit card or debit card sales. Payments are taken automatically from a set percentage of daily card sales until the MCA is repaid.
MCAs are quick financing options that don’t require fixed repayments. But the rates are often higher than other small business loans.
Comparing Installment and Revolving Loans
When deciding between an installment or revolving small business loan, there are several key factors to compare:
Interest Rates and Fees
Installment loans usually have fixed interest rates that remain the same over the full repayment term. Revolving loans have variable rates that fluctuate over time. Rates for revolving loans tend to be higher overall.
Both loan types may also have upfront origination fees or closing costs. These fees are generally lower for installment loans.
Payment Flexibility
Installment loans have structured repayment schedules with fixed monthly payments. This offers predictability in budgeting but less flexibility.
Revolving loans allow you to make payments based on your outstanding balance. You can pay more or less each month depending on cash flow needs.
Borrowing Limits
Installment loans provide a lump sum upfront based on the amount borrowed. Revolving loans have a credit limit or maximum that can be borrowed, repaid, and borrowed again.
For large lump sums, installment loans have higher limits. But revolving loans allow more flexibility in borrowing smaller amounts up to the credit line.
Collateral Requirements
Installment loans usually require collateral to secure the loan, particularly for larger loans and better rates. Revolving loans may be secured or unsecured, depending on the lender, loan size, and your qualifications.
Tax Deductibility of Interest
With installment loans, the IRS generally allows you to deduct interest you pay on the loan if the proceeds were used for qualified business purposes.
Interest on revolving loans is not tax deductible in most cases because the proceeds can be used for non-qualified purposes. An exception is if you use a fixed payment, fixed term revolving LOC.
Choosing the Right Loan for Your Business
Consider your specific needs when deciding between an installment or revolving loan:
- If you need one large lump sum for a major purchase or expansion, an installment loan may suit your needs better.
- If you want flexible borrowing for ongoing expenses and short-term needs, a revolving LOC or credit card may be a good option.
- Analyze your cash flow and ability to make fixed monthly payments. Installment loans have less flexibility but predictable payments.
- Look at interest rates and fees for both loans. Installment loans often have more favorable rates.
- Your credit history also plays a role. Installment loans generally require good credit. Alternatives like MCAs may suit newer businesses.
- Review the borrowing limits and whether they accommodate your financing needs.
- See if the lender requires collateral and if you have assets to secure the loan.
Overall, revolving loans offer more flexibility and easier access to funds but have higher costs. Installment loans provide fixed rates and predictable payments but less flexibility. Assess your situation to pick the best loan type or even use a mix of both.
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Tips for Getting a Small Business Loan
If you’re hoping to get approved for a small business loan, there are things you can do to boost your chances:
- Have a viable business plan - Lenders want to see you have a solid growth strategy and plan for using the funds productively.
- Maintain good personal credit - Your personal credit scores carry significant weight in small business lending decisions. Keep personal scores above 700.
- Build business credit - Having good business credit shows lenders you manage business finances responsibly.
- Provide collateral - Secured loans that are backed by collateral you pledge have better approval odds and rates.
- Lower debt burdens - Keep business and personal debt low compared to income/revenue to qualify more easily.
- Shop lenders - Compare offers from banks, credit unions, alternative lenders, and online lenders.
Alternatives to Small Business Loans
Traditional installment and revolving loans aren’t the only ways to secure financing for your business. Some other options include:
- Crowdfunding – Raising small investments from a large number of backers through sites like Kickstarter and Indiegogo.
- Business grants – Federal or state grants targeted to certain industries, business types, or owner demographics.
- Business credit cards – Cards like the Chase Ink Business cards offer robust rewards and sign-up bonuses helpful for new businesses.
- Investors – Finding angel investors or venture capitalists to invest in your small business in exchange for equity.
- Invoice factoring – Selling unpaid invoices to a commercial factoring company to raise capital against money owed.
The Key Difference Between Installment and Revolving Loans
When it comes down to answering whether a small business loan is installment or revolving, the key difference lies in the repayment structure:
- Installment loans provide an upfront lump sum and are repaid in fixed scheduled payments over a set term.
- Revolving loans offer flexible borrowing up to a credit limit and required payments based on the outstanding balance each month.
Carefully considering your business’s needs and finances can help you determine which type of loan works best. Analyze the pros and cons and work with lenders to secure financing to successfully grow your small business.
Frequently Asked Questions
What is an SBA loan and how does it work?
SBA loans are small business loans partially guaranteed by the U.S. Small Business Administration. They are offered by approved lenders like banks and credit unions. SBA guarantees a portion of the loan, helping entrepreneurs qualify for competitive rates and terms. SBA 7(a) and 504 loans are popular installment loan programs with low down payments.
What is the easiest small business loan to qualify for?
Merchant cash advances (MCAs) often have the easiest approval requirements for small business loans. MCAs provide a lump sum in exchange for a percentage of future credit card sales rather than requiring fixed monthly payments. Approval decisions are based more heavily on monthly sales than personal credit scores.
How much can I borrow with a small business line of credit?
Small business line of credit limits often range from $10,000 to $500,000. Your individual revolving line will depend on factors like your revenues, time in business, credit score, and collateral available. Smaller startup lines may be $10,000-$50,000. Established businesses can secure lines of $100,000+.
Should I use a credit card or loan to finance my business?
If you need a large lump sum, a term loan is preferable to credit card financing, which has higher rates and fees. But credit cards offer convenience and rewards for smaller purchases and flexible spending. Many businesses use a combination of credit cards plus an installment loan or line of credit.
What collateral do lenders look for when approving small business loans?
Common collateral used for secured small business loans includes real estate, equipment, vehicles, and investments. The stronger the collateral asset, the better the loan terms will generally be. Not all lenders require collateral, but pledging assets can help you qualify and get a competitive interest rate.
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