Is a Small Business Loan Installment or Revolving?Differences You Need to Know Between the Two!
It’s not easy to get a small business off the ground, especially if it’s your first business or you don’t have a lot of savings to invest or risk in the business.
That’s where small business loans come into the equation.
Loans can be intimidating if you think of them through a personal finance context since most personal purchases aren’t going towards assets that can grow and appreciate and turn into wealth.
But it’s helpful to reframe a business loan as something that helps you get to your goals more quickly.
A loan for a business can go towards paying employees, opening a new location, advertising, supplies to improve productivity, and a lot more.
As such, a small business loan will generally have a much lower interest rate than something like a personal credit card.
A business loan helps a small business grow more quickly.
If a business has 100 orders for their widget, but only enough cash on hand to service 20 of those orders at a time, then a loan can give them the necessary capital to fulfill all of their orders at once.
That’s a big oversimplification, but putting cash into a profitable business is a great way to grow.
There are many different types of loans, whether it’s a credit card, a line of credit, a loan where you pay installments, a revolving small business loan, and more.
Here’s what you need to know about small business loans, how to use them effectively, and how they work based on which type you use.
Is a Small Business Loan Installment or Revolving?
A small business loan can be an installment loan or a revolving loan. It can be either one of these, it depends on the type of loan you take out and the payment terms that are attached to it.
There are small business loans that are installment, and small business loans that are revolving.
A loan can be either type, so it’s up to you as the business owner to understand the similarities and differences of each type and to determine which one makes the most sense for the financial situation of your business.
We’re going to discuss both types of loans in-depth throughout the rest of the article, but here’s a very quick rundown of the key differences between them.
An installment loan means that the business gets a lump sum of money all at once, upfront, that they can use right away.
It’s kind of like when you take out a loan to buy a car, you’re getting all of the cash upfront to pay for the car, then paying the money back to the lender gradually in installment payments.
A revolving credit line/loan means that you have access to a set amount of capital (your credit limit), but you only borrow it as you need it, instead of a lump sum all at once.
This is more comparable to a credit card, which you can borrow from multiple times a day, or not at all, and you pay back a monthly payment based on how much you’ve borrowed, or pay it back in full at the end of each monthly period.
What is a Small Business Installment Loan?
A small business installment loan is a lump sum of money that a business borrows, usually to make a specifically defined purchase.
This money is typically already earmarked to be spent on something specific, such as:
- Signage for a brick and mortar location
- Advertising (online and traditional)
- Purchasing supplies or new equipment
- An unexpected expense that needs to be covered
- To fund operations during a slow period in the business
There’s a lot more that an installment loan can go towards, it’s not limited to the above ideas.
It really depends on what type of business it is, and where they’re at.
If there’s an expense the business needs to pay, then taking out an installment loan gives the business access to the full sum of the loan all at once, which they can then put towards the purchase.
It doesn’t make a lot of sense to take out an installment loan without something specific to spend the money on because the business is paying interest on the full amount of the loan.
As such, a business usually won’t take out an installment loan just to have the money sitting around in cash.
Benefits of a Small Business Installment Loan
A lump sum to spend
With an installment loan, the key distinction is that you’re receiving a lump sum of money at once, so if you need to make a large purchase, you’re able to use this loan to finance the purchase.
This is useful when you need to make a major purchase or invest in a specific thing for the business, and you’re setting aside this loan to do exactly that.
Granted, with a revolving loan, you could just max out the loan and have access to the funds upfront too, but you’ll likely pay a much higher interest rate for this, which means your monthly payments are going to be going towards more interest compared to other loan options.
In some cases, the interest that you do end up paying towards your small business installment loan can be used as a tax write-off when you prepare and file the taxes for your business.
This is something to keep in mind, since the interest the business is paying on this loan can end up costing a non-insignificant sum of money, and having write-offs for things that the business needs are a helpful way to reduce the total taxes owed at the end of the year.
You’ll make a consistent monthly payment so you can budget for exactly how much it will cost you to have this loan until it’s paid off.
With a revolving loan, your monthly payments will vary from month to month depending on what your balance is at the time. A monthly payment that fluctuates is not as predictable as the set monthly payment you’ll have with an installment loan.
What is a Small Business Revolving Loan?
A small business revolving loan, a revolving line of credit, can come in different forms including financing from vendors and suppliers, a line of credit for a business, or most commonly in the form of a business credit card.
What makes this type of small business loan distinct from an installment loan is that with a revolving credit, the business can borrow exactly how much they need at any given time, they can pay off the balance all at once or in monthly payments, and they can then borrow more money on a revolving basis.
An installment loan gives the business a chunk of money at once, which they pay back over a period of time.
The revolving loan means that the business can borrow any amount that won’t exceed their balance, pay it back, borrow more, and rinse and repeat this process on a monthly basis.
A revolving loan is more flexible, but that also means it can be a bit less predictable if a business is trying to budget in a flat monthly expense.
If you make the minimum payments towards a revolving loan, you’ll end up paying a ton of interest before it’s paid off, if it’s ever fully paid off at all.
With an installment loan, the costs of the loan (interest) are built-in to the monthly payment over a set period of time, so they won’t fluctuate from month to month based on how much you pay.
Benefits of a Small Business Revolving Loan
With a small business credit card, there are all sorts of rewards structures that can end up being very beneficial, especially if you’re being diligent to not carry a balance.
Credit card rewards can be earned in the form of travel points that can be used to purchase airline flights and to redeem for vacations or business trips. Rewards can also come in the form of cash back on every purchase, which is like putting money right back into the business’ bottom line.
Flexibility to access funds as needed
The main benefit of a revolving credit for a small business is that you can withdraw as you need the funds. Rather than setting up the loan and getting all of the money at once (and paying interest on all of it from the very start), you can take $100 here, $150 there, $1000 the next day, and so on and so forth.
You have access to the funds you need when you need them, on a revolving basis, which makes a revolving loan or business line of credit a lot more flexible to use for day-to-day expenses and costs, as opposed to using them for one singular major purchase.
You typically can’t renew an installment loan for a business, you’ll need to take care of the loan and then apply for a new one when it’s time for another large purchase. On the other hand, a revolving loan can be paid off, but the line of credit remains open so that the business can continue to use it.
Great to have for emergencies
Sometimes, there are expenses that creep up out of nowhere, or a business will have a slower month, or just need some extra capital for something that doesn’t justify taking out an installment loan.
These types of situations, whether they are an emergency or not, are the perfect example of when to use a revolving loan. As long as the business can make the minimum monthly payment, they can keep using their business credit card or line of credit.
Revolving vs. Installment: Which Type of Small Business Loan is Better?
Neither of these types of loans is inherently better than the other one because they serve different purposes.
As the person responsible for the finances of the business, it’s up to you to determine which type of business loan makes more sense for each specific situation.
Without knowing the specific terms and interest rates on either loan, just speaking generally, here are the rules of thumb as to which type would suit the business better.
Installment Loans Are Better When…
Consider using an installment loan when some or all of the following guidelines apply:
- A lump sum of cash is needed for a specific purchase,
- Being able to predict the monthly repayments is important,
- A lower interest rate is worth losing some flexibility,
- You won’t need to renew the loan after it’s paid off,
- The business needs commercial real estate, equipment, or microloans.
Revolving Loans Are Better When…
Consider using a revolving credit loan when some or all of the following guidelines apply:
- Cash flow is needed for various operating costs,
- The business wants the option to renew the loan,
- The business needs access to capital on-demand,
- Low monthly payments are needed,
- A credit card is needed to make payments (for example, ordering supplies online).
Keep in mind that these lists aren’t exhaustive and there are other situations where one or the other may be the better option.
Compare interest rates and terms and decide which makes the most sense for the business that you’re responsible for.
There could be a situation in a business where multiple factors are conflicting and it’s less clear which type of loan makes the most sense, so there isn’t necessarily a one-size-fits-all answer but these general guidelines will point you in the right direction to be able to make the right call.
Final Thoughts on Small Business Loans, Installment Loans, and Revolving Loans
Knowing the pros and cons of different financing options can be a very useful tool in your toolbox. Small business loans can be incredibly beneficial in growing a business more quickly, or choosing a less-than-ideal financing option can drastically slow a business’ ability to grow.
Learn the differences between installment and revolving loans, when to use each one, how to identify which type of loan your business needs (and when), and choose wisely!
It’s also very common for a business to have more than one loan, so some loans a business has could be of the installment variety, and other loans that a business carries could be a business line of credit, a business credit card, or other types of revolving small business loans.