As you look at funding options for your small business, you’ll likely see two repayment structures. One structure might require you to repay what you’ve borrowed in monthly installments. The other structure might let you pay things back on your own terms. You might also see the latter category referred to with words other than “loan,” making you wonder: Is a small business loan installment or revolving?
Is A Small Business Loan Installment or Revolving?
Small business loans can be either installment or revolving. SBA 7(a) loans, for example, are installment loans, whereas business lines of credit are revolving. Equipment loans and microloans come in both varieties.
What Are Installment Loans?
Installment loans are any form of funding with monthly payments of the same amount over time. Often, installment loans have longer repayment terms and larger loan sizes than revolving loans.
Some installment loans have fixed interest rates that keep your monthly loan expenses the same over time. Others, such as SBA 7(a) loans, have variable interest rates. Though your principal monthly payment remains constant, the interest you pay over your loan’s lifetime will often add up to less.
What Are Revolving Loans?
Revolving loans are any funding sources that give you a certain amount of money without the requirement to use the entire allotted amount. Business credit cards are an everyday example: You’re not obligated to use the entire $50,000 credit limit on your card.
With any revolving loan, you can borrow up to the maximum amount of the loan for one purchase. You can then use the remaining funds for other purchases or not use any of the leftover money at all. You won’t pay interest or fees on any money you don’t use.
Key Differences Between Installment and Revolving Loans
Installment and revolving loans have clear surface-level differences. These differences, though, don’t entirely speak to the pros and cons of each. The below differences that lie beyond each loan’s surface should help you figure out which loan type better suits your needs.
Revolving loans have the following benefits and drawbacks compared to installment loans:
- You can take out less money than the total loan amount. Let’s say you need $5,000 extra to cover payroll this month after bringing on a new employee. If you take out a revolving loan with a $10,000 credit limit, you can use just the $5,000 you need for payroll. You can leave the remaining $5,000 untouched without paying any fees on it.
- You can take out money more than once. If you suddenly need the rest of that $5,000 credit line, you can easily access it at any time with a revolving loan. The only exception is if your credit line has an expiration date. In that case, you would need to pull that $5,000 before your credit account closes. Either way, you still won’t be charged for any money you didn’t borrow.
- You can repay the loan on your own schedule. Revolving loans don’t come with required monthly payments. You can repay what you’ve borrowed in one lump-sum payment or make several smaller payments. As long as you repay everything by the due date, the choice of when and how you do so is up to you.
- You can apply more easily. Some business lines of credit don’t require borrowers to have good business or personal credit scores. These credit lines are typically easy to apply for, meaning that you can get funding sooner than later to shore up your cash flow.
- You can avoid collateral. Some small business loans are only accessible if you put up certain assets as collateral. This way, the lender can seize your assets and sell it to recoup any portion of the loan that you couldn’t pay. Some revolving loans lack these collateral requirements. They can be safer bets if you’re worried about losing your assets.
- You can’t claim them as tax deductions. Some types of loans can lower your taxable income. Revolving loans typically don’t come with this advantage.
- Your credit score can fall. Between the time you take money from your revolving credit line and repay it, your credit score can decrease. If you use most or all of your credit line and leave it unpaid for a while, your overall credit health may be impacted.
- Your interest rates will be higher. In almost all cases, lenders charge much higher interest rates on revolving loans than installment loans. In fact, some business credit lines can have an APR as high as 99%. That could mean you wind up paying back twice the amount that you borrowed.
The pros and cons of installment loans are as follows.
- You receive the entire sum upfront. With installment loans, $100,000 is $100,000 – no more, no less. That’s great if you need to immediately cover expenses of that amount. It also eliminates the possibility of not paying fees or interest on a certain portion of your loan. That said, certain SBA loans are fully amortized with variable interest rates, meaning their fees can be quite low.
- You’ll know exactly what to pay and when. The contracts behind SBA and term loans – both among the most common installment loans – should clearly state your repayment schedule. You’ll know exactly how much you must pay each month and on what date. This predictability can help you better budget for loan expenses. It can also help you remember to repay your loans and avoid late payment penalties.
- You’ll have access to more money. Often, installment loans offer an order of magnitude more funding than revolving loans. That means if you need lots of money for a specific purpose – say, buying commercial property – installment loans will suit you better.
- Your fees will be lower. If you were to compare an installment and a revolving loan of the same size, you’d likely see that the installment loan has lower fees. Sure, the fees for any type of loan can vary depending on the lender, but even the highest installment rates typically fall below revolving rates. As mentioned earlier, some revolving loans have APRs of 99%, whereas the best installment loans have rates one-tenth that much.
- You’ll face penalties for late payments. Since installment loans come with a set repayment schedule, you’ll face fees if you make payments after your deadlines. Some loans also come with prepayment penalties if you decide to pay off your full balance before the payment term ends.
- You’ll face more challenges getting approved. Installment loans often have stricter qualification requirements. You’ll likely need a great credit score, and your business will likely need to have been in existence for at least two years. That said, many small business funding experts still advise any borrower who might qualify to pursue these loans.
- You’ll need a long time to apply. Installment loans’ steep qualifications introduce lots of paperwork, meaning the application process can be lengthy. But that’s changing. Certain online installment lenders have developed digital applications that streamline the whole process.
Which Is Better for a Small Business Loan: Installment or Revolving?
Your choice of installment or revolving loan will ultimately come down to two things. First, you’ll need to be clear on how you’ll use loan proceeds. Second, you’ll need to know how you can best repay it.
If you need a loan to consolidate your business debts, revolving loans might miss the mark. You’re best off using them to cover payroll, inventory, office furniture, and other tangible items. Installment loans are a better pick for debt consolidation, commercial real estate purchases, and working capital.
Installment loans are also superior if you fare better when you mark down predictable monthly payments in your business budgets and spreadsheets. If you have wiggle room to cover loan expenses when and however you please, then revolving loans should work for you.
In either case, if you’re more used to breaking even than making a profit, you may prefer installment loans. That’s because the best installment loans come with low fees and interest payments that often decrease over time. SBA 7(a) loans are a great example, and you can easily find and apply for them from your office or home.
How to Apply for an Installment Loan
Maybe you’re now ready for funding in large amounts that you can pay back over long periods with small monthly installments and low interest rates. You might also be worried about qualifying for such loans, dealing with a tedious application process, or waiting forever for funding. With SmartBiz®, you can quickly find out whether you qualify – and apply just as quickly for funding that arrives not long after. Just create a SmartBiz account to get started.
WHAT YOU NEED TO KNOW: The SmartBiz® Small Business Blog and other related communications from SmartBiz Loans® are intended to provide general information on relevant topics for managing small businesses. Be aware that this is not a comprehensive analysis of the subject matter covered and is not intended to provide specific recommendations to you or your business with respect to the matters addressed. Please consult legal and financial processionals for further information.