A $400,000 term loan and a $400,000 line of credit put the same amount of money within reach and then behave nothing alike. One creates a fixed payment that starts the month after closing whether or not you use the funds. The other creates a right to borrow that costs almost nothing until you draw on it, and disappears at renewal if the file changes. They are underwritten against different questions, priced on different mechanics, and they land on your debt service coverage in completely different ways.
The rule that settles most of these decisions is old and unglamorous: match the term of the money to the life of the thing it buys. Capital that funds something permanent: a machine, a build-out, a partner buyout, retiring an expensive obligation, should be repaid across the life of what it bought. Capital that funds something that turns over: inventory that will sell, receivables that will collect, a payroll gap that closes in six weeks, should be borrowed and repaid on that same cycle. Nearly every expensive structuring mistake in working capital is a violation of that one sentence.
What a term loan actually is
A term loan advances a fixed principal amount once, then amortizes it over a stated period through scheduled payments of principal and interest. Amortization is the defining feature, not the interest rate. The payment is contractual, it begins on schedule, and it does not care whether the money is working. Once principal is repaid it is gone: you cannot redraw it without a new application.
That has a consequence most operators underweight. The full annualized payment enters your debt service the moment the loan closes. If you borrow $400,000 on a five-year amortization at an illustrative 11 percent, the payment is roughly $8,700 a month, or about $104,000 a year of debt service. Every coverage calculation any lender runs on you for the next five years includes that $104,000, even in the months when the borrowed money is sitting in the operating account doing nothing.
What a line of credit actually is
A line of credit is a commitment to lend up to a stated limit. You draw what you need, interest accrues only on the balance actually outstanding, and repaying principal restores availability. There is no amortization schedule in the term-loan sense; most lines require interest monthly and principal on demand or at maturity, and many carry a cleanup or resting requirement that forces the balance to zero for a stretch each year.
The tradeoff is impermanence. Lines are typically reviewed annually, and the commitment can be reduced, repriced, or not renewed if the financials move. Secured lines are usually governed by a borrowing base that recalculates monthly against receivables and inventory, which means your available limit can shrink in exactly the month your collections slow. A term loan cannot be taken away from you mid-term for a bad quarter. A line can shrink.
The comparison, line by line
| Dimension | Term loan | Line of credit |
|---|---|---|
| Best fit | Permanent or long-lived uses | Fluctuating, self-liquidating uses |
| Interest charged on | Full outstanding principal | Drawn balance only |
| Repayment | Scheduled principal and interest | Interest monthly; principal as cash allows |
| Redraw after repayment | No | Yes, up to the limit |
| Effect on coverage | Full annual P&I from day one | Interest, or an imputed fully-drawn figure |
| Renewal risk | None during the term | Annual review; limit can shrink |
| Common collateral | The asset financed, plus a blanket lien | Receivables and inventory |
| Fee pattern | Origination at close | Origination, unused-line fee, annual renewal |
Read the coverage row twice. It is the single most consequential difference and the one operators discover last, usually when a second lender declines a file that looked fine to them.
Where the line wins
Seasonal inventory and pre-season buys
If you build inventory in the spring and sell it by late summer, the need exists for roughly five months a year. Financing it on a five-year amortization means paying for the money in the seven months you do not need it, and repaying principal on a schedule that has nothing to do with when the inventory converts to cash.
Receivable timing gaps
A contractor who bills at 30 days and gets paid at 55 is financing three to four weeks of payroll and material on every job. That gap opens and closes continuously. A revolver is built for exactly this shape: draw when you fund the job, repay when the invoice clears, pay for the days you were actually out of pocket.
Opportunistic purchases
A distressed inventory lot, a bulk buy at a real discount, a supplier clearing a line: these need speed and short duration. A facility already in place, already documented, with availability sitting there, is the only structure that answers a two-day window.
Where the term loan wins
Anything permanent
Equipment, leasehold improvements, an acquisition, a partner buyout, a new location. These consume cash once and produce returns over years. Funding them on a revolver creates a balance that never comes down, which is a problem discussed at length below.
Payment certainty
A fixed-rate term loan makes the obligation knowable for the whole term. If your margins are thin enough that a few points of rate movement changes the plan, certainty is worth paying for. Most revolvers float.
Killing short-duration debt
This is the paradox worth naming. Short-term advances with daily or weekly remittance are the most expensive money in commercial finance measured by annualized debt service. Refinancing them into a longer amortization is one of the few moves that reliably improves coverage inside a single quarter. Here the term loan is the working-capital fix, because the problem is not a timing gap: it is a repayment schedule that outruns the business.
Cost is not the interest rate
Comparing a line and a loan on quoted rate alone produces the wrong answer roughly every time, because the two facilities charge for different things. A term loan charges interest on the full balance from day one and usually carries a single origination fee. A line charges interest only on what you use, and then adds carrying costs that exist whether you use it or not: an unused-line or commitment fee on the undrawn portion, an annual renewal fee, and on asset-based facilities, field examination and collateral monitoring costs.
The practical implication is that low utilization is expensive per borrowed dollar. A large line you rarely draw on can produce an effective cost well above the stated rate once fixed fees are spread over a small average balance. A line you use heavily converges toward its stated rate. Neither is wrong; you just need to price the facility you will actually use, not the one on the term sheet.
What the desk is thinking in each case
The two requests get read differently. A term loan request is a cash-flow question: does adjusted EBITDA cover total annual debt service, including the new payment, with enough headroom to survive a bad quarter? Collateral matters, but coverage sets the size.
A line request is largely a collateral and behavior question: what receivables and inventory support the limit, how clean is the aging, how concentrated is the customer base, how does the operating account behave day to day. Many desks also test a line against coverage by imputing interest as if the facility were fully drawn, so a $500,000 line at an illustrative 10.5 percent may be modeled as roughly $52,500 of annual interest expense in the coverage calculation even if you never draw it. That treatment varies by lender and program, and it is worth asking about directly.
Work this before you ask for either one
- Write down the specific use of funds in one sentence, and say whether the cash comes back within twelve months.
- Chart the need month by month for the last two years: peak, trough, and how many months a year the balance would be above zero.
- Compute your current annual debt service, then add the term-loan payment you are considering and recompute coverage.
- Compute coverage again assuming a line is fully drawn at interest only, so you know both versions of the number.
- List the receivables and inventory that would support a borrowing base, with the aging attached.
- Total the non-interest costs of each structure: origination, unused-line fee, annual renewal, field exam.
- Check whether any existing loan agreement restricts additional indebtedness or liens before you apply anywhere.
The three failure modes worth avoiding
- The evergreen revolver. A line drawn for a permanent need never comes back down, and a balance that has not touched zero in two years reads as a facility funding losses or fixed assets. It is the most common reason a limit is cut at renewal.
- Terming out a timing gap. Financing a recurring receivable cycle on a five-year note means paying for money continuously to solve an intermittent problem, and burning coverage capacity you will want later for equipment or real estate.
- Sizing term debt to peak need. Peak is a line-of-credit number. Amortizing the worst week of the year loads the business with a payment it does not require for the other fifty-one.
Can I have both a term loan and a line of credit at the same time?
Yes, and for many operating businesses that is the right end state: term debt for the fixed assets, a revolver for the cycle. What matters is that the combined annual debt service still clears coverage with headroom, and that the first lender's documents permit additional indebtedness and a second lien position. Check the negative covenants in any existing agreement before you apply, because a technical default is a worse outcome than a slower approval.
Does an unused line of credit hurt my ability to borrow elsewhere?
It can. Many underwriters treat an undrawn commitment as contingent liability and test coverage assuming it is fully drawn at interest only. A large unused line therefore consumes some borrowing capacity even when the balance is zero. If you are about to request term debt and carry a line you no longer use, reducing or closing it is sometimes the cheaper move.
Why did my line get cut when nothing went wrong?
Secured lines are usually governed by a borrowing base, so availability tracks eligible receivables and inventory rather than the stated limit. A slow collection month, a customer aging past the ineligible threshold, or a single customer growing past a concentration cap can all reduce availability without any decision by the lender. Annual renewals can also reprice or resize a facility based on updated financials.
Is a business credit card the same thing as a line of credit?
Mechanically it revolves, so it solves short gaps, but it is not a substitute for a working-capital facility. Limits are usually far smaller relative to revenue, the carrying cost on a revolved balance is typically much higher than commercial line pricing, and card balances do not build the kind of banking relationship or borrowing-base discipline that supports a larger facility later.
What is a cleanup or resting requirement?
It is a covenant requiring the line to sit at or near zero for a defined period each year: often something in the range of thirty consecutive days, though the specific requirement varies by lender and facility. Its purpose is to prove the line is funding a cycle rather than a permanent deficit. If you cannot rest the line, that is diagnostic information: the underlying need is probably term debt.
Which one is faster to close?
It depends less on the product than on the collateral. An unsecured or deposit-sized line with modest limits often moves quickly because there is little collateral to examine. An asset-based line with a borrowing base can take longer than a term loan because it requires a receivables analysis and sometimes a field exam. Timelines vary widely by lender, program and how complete your documentation is at submission.
If I only need money for four months, why not just take the term loan and pay it off early?
Sometimes that works, but check the note first for prepayment penalties, minimum interest provisions or yield maintenance. Also remember that the annual debt service figure follows you into any other credit decision until the loan is actually retired, so an early-payoff plan does not help a file that is being underwritten in month three.
Where to start
Take the use of funds and answer one question honestly: will this money come back to the operating account within twelve months through the ordinary course of business? If the answer is yes, you are looking at a revolver and the work ahead is collateral quality: the aging, the concentration, the borrowing base. If the answer is no, you are looking at term debt and the work is coverage, adjusted EBITDA against total annual debt service including the new payment.
If the answer is both, which is common for growing businesses carrying expensive short-term debt while also funding a seasonal cycle, do not force one structure to do both jobs. That is the case a combined facility is built for, and it is worth structuring deliberately rather than by accident.
Qualified Commercial Underwriting Desk
Credit and capital markets
The Qualified Commercial underwriting desk reviews commercial real estate, dealer and Main Street files daily. The Academy is written from that work (how files are actually read, priced and declined) rather than from a rate sheet.
Educational content only. Nothing here is a commitment to lend, an offer of credit, or tax, legal or accounting advice. Program terms, timelines and thresholds vary by lender, file and market conditions, and any figures shown are illustrative.