When it comes to financing your operational needs and business’s growth, choosing between a line of credit vs. a loan might seem a confusing task for you. While both options can provide required financing for personal or professional purposes, they have distinct features that make them fit for different scenarios. Today, we are going to give a complete understanding of both options so that you can determine which one aligns best with your situation. 

A line of credit (CL) is a special type of bank loan for citizens and businesses: legal entities and individual entrepreneurs. The peculiarity of this loan is that the client can receive money several times exactly when he needs it most. To do this, you do not have to fill out documents every time. Having signed an agreement once, you can count on several mini-loans or a revolving loan.

CL is a convenient financial instrument for small and medium-scale businesses as it makes it possible to obtain additional funds for every day or planned expenses.

What is a loan?

Opposed to a line of credit, with a loan, a lender —transfers a fixed amount of money at the beginning of a transaction to an individual or a business. The borrower guarantees to repay that principal amount, plus the agreed interest amount, in one or more installments over an agreed period of time.

It is suitable for those individuals or businesses that want a lump sum amount to finance bigger one-time purchases.

What is the difference between a line of credit and a loan?

The bank can open a CL for an individual entrepreneur or a legal entity if it is confident in its reliability. Individual entrepreneurs who have not yet managed to earn a positive reputation may have difficulty obtaining this service.

Applying for a line of credit is not much different from obtaining a regular loan. If you are an individual entrepreneur or the founder of an organization, inform the bank that you want to receive a CL. The bank will check your solvency. If everything is in order, he will approve the loan, offer terms, and conclude an agreement. However, there is a difference between a line of credit and a loan. Let’s look at the differences in the table:

What types of credit lines are there?

For citizens, the CL service is presented in the form of issuing a credit card or connecting an authorized overdraft for a debit card. In both cases, a person can borrow money from the bank and return it an unlimited number of times until the contract expires.

For individual entrepreneurs and organizations, there are several types of CL: renewable, non-renewable, frame, on-call, and contract. Let’s consider each option in more detail.

Renewable

Renewable CL is also called revolving CL. According to the terms of the agreement, the client can use the same limit multiple times. If he withdraws money and then pays off the debt, then this money is again available for withdrawal. You can use funds in this way an unlimited number of times until the contract expires.

Non-renewable

A non-revolving line of credit (NCL) is also called a simple line. According to the terms of the agreement, the client receives money in several tranches. He uses these funds for his needs, after which he repays the debt for each tranche. Once a payment is counted toward the body of the debt, it is no longer available for withdrawal. The client can withdraw money until he reaches the limit specified in the agreement. To receive additional funds, you need to open a new CL.

A non-revolving CL is suitable for financing project tasks that are one-time in nature. For example, for the purchase of equipment, payment for which is made according to a predetermined schedule.

Framework

A framework credit line is the only type of credit line for which the purpose of use must be indicated. The borrower must provide the bank with information about what he plans to spend the money on. The agreement also specifies the validity period and the ability to renew the credit line.

This banking product is suitable for regular business tasks, such as purchasing goods, raw materials, or consumables.

On-call

An on-call credit line is issued for a long term and is technically similar to an overdraft. Borrowed funds are repeatedly available to the client, but only after he has fully repaid the previous debt.

Contract account

A contract account credit line involves opening an active-passive account for the client. This account holds business money and borrowed funds. This type of CL is also technically similar to an overdraft.

Contract accounting helps to avoid cash gaps. For example, if a client urgently needs to pay a supplier, he can use borrowed funds. The loan debt is repaid automatically when profit is received into the businessman’s active-passive account.

What are the pros and cons of a line of credit?

This banking product, like any other, has its pros and cons. Let’s look at them in detail:

Pros of line of credit 

• You save time on paperwork. You do not need to prove your solvency and sign an agreement every time you need a loan.
• You manage overpayments. From the line limit, you take only the amount you need and then pay interest only on it. When you return part of the amount spent, the interest is reduced proportionally.
• Flexible terms are available to you. The tranche size and the debt repayment period are related. If an individual entrepreneur spends money and then quickly returns it, then the overpayment will be minimal.
• Every time you need money, you can take it from the credit line limit. Borrowed funds are available at any time during the entire term of the agreement.
• You can extend the contract term and increase the limit. To do this, you must comply with the terms of the agreement.

Cons of the line of credit

• The bank considers applications for CL longer than for loans. He needs to assess the prospects for the development of your business, especially if you are an individual entrepreneur or recently registered.
• If you have a legal entity, then you are required to notify the bank of any changes in the statutory documents. For example, if a new accountant appears, new founders are added, or the type of activity changes, you need to provide the bank with documents.
• You must use the service without violating the terms of the contract. If you open a private account “just in case” but do not use it, the bank may issue a fine or block the account.
• Since the repayment schedule is free, you must ensure compliance with it yourself. This requires responsibility and discipline from the individual entrepreneur.
• If a technical overdraft occurs on the credit line account, the bank charges a large commission for it.

How to open a line of credit?

To open a credit line, an individual entrepreneur or the founder of a company must send a request to a credit institution, talk with the manager, and send documents that will prove the reliability of the business. Here are the documents banks usually request:

• Passport of the individual entrepreneur or founder of the organization (original and copy);
• TIN and business registration certificate;
• Financial statements for the last six months;
• Turnover on all accounts;
• Business plan;
• For a legal entity – all constituent documents;
• Liquid collateral may include movable and immovable property, equipment, machinery, goods, land, and securities.

The bank may also request additional information that could characterize you as a reliable client. After checking the documents, the credit institution will offer conditions: the amount of the CL limit, the loan term, and the interest rate. In the future, these conditions can be changed, for example, by increasing the limit or term.



Both a loan and a line of credit are convenient financing options, but you should choose between the two wisely by keeping in mind your specific situation and needs. Understanding the terms and conditions for both is also essential in making the right decision; in such a case, consulting a qualified finance advisor is essential.