Are small business loans installment or revolving? It depends on loan type. Equipment financing, term loans, and other secured loans are paid in installments. 

Can you imagine a world without credit? Would that mean everyone is rich? Well, not exactly. In any case, small enterprises thrive by borrowing money that would cover day-to-day business costs or future financial needs. Lenders will loan you the money based on your capacity to pay, your credit history, among other factors. You know that once you’ve secured a small business loan, you need to repay it one way or another. But, what are you getting yourself into in the first place – is it an installment loan, revolving credit line, or both? Before your questions drown you in confusion, let’s get right to it.

How a small business loan works

Whether growing or established, small businesses are fueled by credit that comes in the form of loans. For startups, loans often serve as working capital, while medium to large enterprises can use them for expansion plans or supplemental funds. Such loans also help with cash flow, equipment purchase, fund purchase orders, increase inventory, pay for operational costs and recurring expenses.

A small business loan allows you to take advantage of business opportunities you will otherwise miss if you couldn’t borrow money to grab them. That is why when used responsibly, personal loans or business loans can contribute to your financial success.

Applying for a business loan
While the idea of a business loan may seem exciting and daunting at the same time, you need to ask yourself first why you would want it. Your loan purpose is a crucial factor before a lender approves your application. Make sure you have your documentation in place as well as your detailed business plan, collateral (if necessary), and other requirements. Conduct your research and compare lenders before deciding which one you will pursue your application with. Your fund sources include banks, online lenders, credit unions whose offers vary depending on whether they are installment or revolving accounts.

Installment loans vs revolving credit lines

Installment loan

Longer-term and regular repayments characterize an installment loan. A mortgage loan, SBA loan, term loan, personal loan, and student loan are some examples of installment credit. Each payment you make gradually decreases your balance, prioritizing interest charges over principal.

For instance, you have a term loan for 100,000 dollars payable for five years, at 10 percent APR (Annual Percentage Rate) for 2,500 dollars per month. A sample breakdown of the monthly installments would be 2,000 goes to payment of interest charge while 500 dollars is deducted from your loan principal in the first few months. But perhaps in the third year, it changes to 500 dollars for interest, and 2,000 for the principal, as more payment gets applied to your balance.

Often your payment amount is fixed depending on the nature of your loan’s interest rate. As such, your installments may change when you have a variable interest rate business loan. It means your interest rate is dictated by the federal government as expressed in the prime rate. While it is variable, there is also a chance that it will not change based on a stable market. Many installment loans are secured either by collateral or a personal guarantee, where the business owner will be personally liable even if it’s a business loan. Student loans are just one of the very few installment loans that do not require collateral as the federal government provides them.

Salient features of installment loans

Lump-sum upfront proceeds
An installment loan may be your answer when you need a considerable amount of money. It would allow you to take advantage of business opportunities that can slip momentarily if you didn’t have access to a fixed lump sum.

Monthly payments
Installment loans entail regular payments within a specified longer repayment period. With a fixed interest rate, you can prepare your budget ahead of time to keep your credit in good standing because you’ll be paying the same amount throughout. Variable interest rate loans would mean different possible amounts every cycle. When they do change, they generally stay within range of your payments.

Tax deductions
Your loan proceeds are not considered revenue; hence you don’t have to account for them in your tax filing. On the other hand, the interest you pay may be tax-deductible.

Additional fees
On top of your interest, you will also pay the origination fee, administrative fee, and application fee. There are late and prepayment penalties if applicable.

Pros of installment loans

predictable payment
higher loanable amount
upfront loan
lower interest rates

Cons of installment loans

longer processing time
stricter requirements
requires a form of security or collateral
late penalty charges

Revolving line of credit

On the other hand, a revolving line of credit is a financing scheme where a borrower is provided with a set amount they can access in portions or as needed. It is typically sought to help manage cash flow for small businesses. This revolving loan is repaid during each billing cycle according to the borrower’s capacity and the minimum payment amount.

For example, let’s take a credit card with a credit limit of 10,000 dollars. You use it to purchase items worth 2,000 dollars; hence you now have 8,000 dollars remaining on your credit card, which you can continue to use if necessary. When you pay the 2,000 dollars on time, your credit limit is renewed to 10,000 dollars. This cycle continues for as long as you manage your credit well enough.

Provided they meet the minimum payment, if there is one, they can maintain their credit and get charged with an interest rate based on the drawn amount. Repayments are then funneled back to the available credit. Credit cards and business lines of credit are popular forms of revolving loans available for small business owners.

Salient features of revolving credit

Funds at your disposal
The lender will approve your credit limit, the maximum amount of funds available to you. As such, you can access any amount within this limit when you need it. At the same time, you will only be charged based on your withdrawal amount and not on the entire sum allocated for you.

Earn rewards
When using business credit cards for a major purchase, you have the bonus feature of earning points which you can exchange for various rewards. You can also skip paying for interest when settling the balance in full on your due date. This condition means you get to enjoy credit for roughly 30 days or so without being charged interest.

Additional fees
You will pay the application fee, membership fee (for business credit card), and the origination fee (for every amount drawn from the credit line). There is a late fee and prepayment fee charged when applicable.

Pros of a revolving line of credit
flexible borrowing
quick application process
collateral may not be required
no-interest option (for business credit card)

Cons of revolving credit
higher interest rates on the unpaid balance
requires strong credit score
not qualified as tax-deductible
annual fee

How are installment and revolving credit different from one another?

To further illustrate the difference between installment credit and revolving line of credit, let’s use a loanable amount of 20,000 dollars as an example. Under a revolving loan, you can opt to take out 5,000 dollars for starters and make succeeding withdrawals from the remaining credit. Unlike revolving credit, you will only get the lump sum or the whole loanable amount in an installment loan.

Even if you’ve paid the amount you borrowed from your credit line, you can simply draw another amount when you need it because it is readily available for you. But with installment loans, you need to reapply anew once you’ve fully paid them.

When do you start paying?

Payment for the installment loan will commence after the loan proceeds have been released to the consumer, usually one month later. The amount you pay remains consistent during your loan term except if you have a variable rate scheme. This scheme helps relieve your cash flow given the repayment period. You also pay after you draw funds from your revolving line of credit but will depend on their amount to determine your minimum payments which change every billing cycle.

3 main factors to consider when applying for business loans, whether installment or revolving

Credit history

Whether personal or business, your credit score should at least meet the preference of lenders, which many have put at 700. You can ask for your credit report from credit bureaus and several financial service providers if you are unsure you have at least an acceptable credit score. When your score is low, it does not necessarily mean you have zero chance of securing any financing. Many online lenders offer loans that accommodate borrowers with low credit scores. However, expect to have less favorable deals than you would if you have strong credit.

Business plan

Small businesses and startups should prove to their lenders that they have the growth potential and have a detailed plan on how they will achieve their projections. It would be best if you were prepared to justify your intended loan amount by submitting your financial statements, list of business assets, and projected income after acquiring the details you need.

Collateral

Borrowing money is not as easy as telling someone you need it, and they’ll give it to you, end of the story. Lenders need assurance that the money they will lend you will be paid back. One way to satisfy this condition is by asking the borrower for collateral. A secured loan requires any tangible asset with considerable value, such as property or the item you intend to buy using the loan amount itself. 

When the borrower is unable to continue their repayment for some reason, the lender will seize the collateral as payment for the installment debt as indicated in the loan agreement. You can also present bank deposits or stock certificates for this purpose. In the absence of collateral, lenders may also ask for a personal guarantee or bank lien to support your loan application.

Impact of installment and revolving loans on credit score

Installment loan

There is a common misconception that the higher your credit utilization rate is, the more it will harm your credit score. 

Credit utilization rate is the ratio of your actual loan and the maximum allowable amount. Usually, the borrower would max out the amount approved under an installment type. Remember that this amount was approved based on your income capacity to repay; hence it will not affect your credit score negatively per se. What would is if you have too many simultaneous loans, more than you can afford to pay, and your inability to pay them on time.

Revolving loan

Just like installment loans, your payment history forms a considerable part of your credit score, which could be up to 40%. However, this is where the credit utilization rate would matter next to timely payments. Financial advisors recommend limiting usage to under 30 percent to maintain a good score. Even better if you will pay your balance in full or revolved balance at the soonest to renew your small business line of credit.

When you have trouble paying for the outstanding balance of your credit card, considering the high-interest rate, a consumer will turn to borrow money via an installment to pay it off. This way, what would typically be up to 25% APR has dramatically reduced to 7%, which is significant savings for the borrower.

Which is best for credit score?

While both loans carry weight on your credit score, a revolving account earns more points than installment credit. Sure, you pay your installment loan on time and carry it through to its last final due, all of which reflects good credit. But when you have a credit line that you can manage responsibly, it is rewarded with a much higher credit score. You see, having access to funds all the time is a very tempting proposition and can easily go haywire if the consumer does not stay on top of their business finances and get into deeper debt. It is why revolving credit is a key factor for lenders that provide them insight into your borrowing behavior and holds more weight than installment credit when it comes to giving you credit points for it.

Final thoughts

So, is a small business loan installment or revolving? We now know that it is both, and choosing which to get largely depends on your business needs and qualifications. Whatever you choose, being a responsible borrower will not only benefit your lender but, more importantly, yourself and your credit report.