Revolving Line of Credit vs. Term Loan

A revolving line of credit vs term loan decision is really a question about what you are financing and for how long. A revolver gives you a limit to draw on, repay and draw again, which suits fluctuating working capital needs. A term loan gives you a fixed amount repaid on a schedule, which suits assets and projects with a known life. Using the wrong one costs money and creates risk. This guide compares the two, runs a worked cost example for equipment and one for working capital, and sets out a decision guide. It supports cash flow management and extends the discussion in working capital loans vs. lines of credit.

How they differ

Terms vary by lender. Always read the documents.

The matching principle

The central rule is to match the term of the financing to the life of what it pays for.

• Short-term, recurring needs (receivables and inventory that turn over within months) fit a revolver, because the cash comes back as customers pay.
• Long-lived assets and projects (equipment, buildings, acquisitions) fit term debt repaid over their useful life, because the cash comes back slowly through use.

Mismatches cause problems. Financing equipment with a revolver means the repayment depends on the line staying available and on rates staying acceptable. Financing seasonal inventory with a term loan means paying interest on money you do not need part of the year.

Example 1: financing equipment

A hypothetical company buys equipment for $240,000 with a useful life of five years. It compares two choices.

Term loan: 60 months at 8 percent, equal monthly payments.

• Monthly payment ≈ $4,866
• Total payments = 60 × $4,866 = $291,972
• Total interest ≈ $51,972

Revolver: draw $240,000 on the line at a floating 9 percent, interest only.

• Annual interest = $240,000 × 0.09 = $21,600
• Over five years, interest is about $108,000 if the balance stays unchanged and the rate stays at 9 percent.

The revolver has no scheduled principal repayment, so cash flow looks easier at first. But the balance is never reduced unless the company chooses to, the rate can rise, the lender can reduce the line and the line is not available for the working capital it was meant to support. In the term loan, principal falls with each payment, and the cost is known. For this purchase, the term loan is safer and cheaper in total interest, despite higher monthly payments. A blend can work too, such as a down payment from cash and a shorter term loan.

Example 2: working capital

The same company has a seasonal need that peaks at $150,000 for three months each year.

Revolver: limit $200,000 at 10 percent on drawn amounts, with a 0.5 percent fee on the limit.

• Interest = $150,000 × 0.10 × 3 / 12 = $3,750 (assuming the full amount is drawn for three months)
• Fee = $200,000 × 0.005 = $1,000
• Total ≈ $4,750

Term loan: $150,000 for 12 months at 8 percent, equal monthly payments.

• Monthly payment ≈ $13,048
• Total interest ≈ $6,576

Even at a lower rate, the term loan costs more in this case because the company borrows for twelve months to meet a three-month need. The revolver wins. If the same $150,000 were needed all year, the revolver at 10 percent would cost $15,000 in interest, and the amortizing term loan would cost less, because the balance falls. The shape of the need decides.

Costs to compare

Compare the total cost on your expected borrowing pattern, not the headline rate.

• Interest rate and index: fixed or floating, with any floor or cap.
• Origination or closing fees.
• Commitment or unused-line fees.
• Annual renewal and monitoring fees.
• Prepayment penalties on term loans.
• Minimum balance or minimum interest requirements.
• Legal and appraisal costs.

Convert fees into an effective annual rate for your use case to compare fairly.

Fixed versus floating rates

Revolvers are usually floating, and many term loans are too. A change in the benchmark rate flows straight into your interest cost.

If your forecast cannot absorb a rise of this size, consider fixing part of the debt through a fixed-rate term loan or an interest rate swap. Swaps and similar products add complexity and cost, so get qualified advice and a written policy first. Include a rate-rise case in your downside scenario. See cash flow scenario planning.

Covenants and conditions

Both products carry covenants. Common ones:

Model covenants in your downside case before signing. See liquidity ratios and cash flow scenario planning. Understand what happens on a breach: a waiver fee, higher pricing or a demand for repayment.

Risks specific to each

Revolver risks

• The lender may cut the limit, freeze the line or decline renewal, especially when your results weaken.
• Floating rates can raise the cost.
• Borrowing base shrinkage reduces availability when receivables age or inventory slows.
• Using it for permanent needs creates refinancing risk.

Term loan risks

• Fixed payments continue when cash is short.
• Prepayment penalties can make early repayment costly.
• Long terms can leave you tied to a lender or a rate that later looks poor.
• Over-sizing means paying interest on unused cash.

Decision guide

Many companies use both: a revolver for working capital and a term loan for equipment or expansion.

Alternatives and complements

• Equipment financing or leasing, secured by the equipment.
• Asset-based lending, which ties availability to receivables and inventory. See asset-based lending explained for mid-market companies.
• Inventory financing. See inventory financing.
• Invoice financing. See invoice factoring vs. invoice financing.
• Equity, for growth that debt cannot support.
• Better working capital management, which reduces what you need to borrow. See working capital optimization.

Preparing the application

1. Know the need: amount, duration, use and repayment source.
2. Prepare the forecast: 13-week and 12-month, with a downside. See how to build a cash flow forecast you will actually use.
3. Assemble documents: financial statements, tax returns, aging reports, inventory reports and debt schedule.
4. Shop the market: banks, credit unions and alternative lenders, and compare term sheets side by side.
5. Negotiate: pricing, covenants, fees and renewal terms.
6. Plan the exit: how and when the facility is repaid or refinanced.

For product companies, a better demand plan means smaller peaks and more predictable borrowing. See demand planning and inventory optimization.

Common mistakes

• Financing long-lived assets with a revolver.
• Financing short-term needs with a term loan.
• Comparing rates but ignoring fees.
• Skipping covenant modeling.
• Assuming a revolver will always be available.
• Over-borrowing "just in case." See how to bridge a cash flow gap without overborrowing.

FAQs

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

A line of credit lets you borrow up to a limit, repay and borrow again. A term loan provides a fixed amount that you repay on a schedule.

Which is cheaper, a revolver or a term loan?

It depends on how much and how long you borrow. A revolver is usually cheaper for short, variable needs because you pay interest only on what you draw. A term loan can be cheaper for long-lived needs because the balance amortizes.

Can I use a line of credit to buy equipment?

You can, but it is usually better to use a term loan or equipment financing matched to the asset's life. A revolver may be reduced or not renewed, leaving you with a repayment problem.

Do both require collateral?

Often, yes. Lenders commonly take security over business assets and may require personal guarantees. Terms vary.

Can I have both at once?

Yes. Many companies use a revolver for working capital and a term loan for equipment or expansion.