SBA Loan vs. Business Line of Credit: Pros and Cons

What is an SBA loan?

SBA loans are government-approved loans designed to support small businesses and facilitate a safer, smoother process for both lenders and borrowers. By establishing guidelines and guarantees for business loans, SBA programs reduce lender risk and provide small businesses easier access to necessary capital. 

Generally, SBA doesn't provide the loans themselves. Instead, they partner with lenders to offer a series of loan programs. Once a business chooses the right program for their financing goals, SBA matches it with a lender.

SBA does, however, directly offer low-interest loans to help businesses and homeowners recover from declared disasters.  

Types of SBA loans

SBA offers four main loan programs.

• 7(a) loans: Provides up to $5 million in funding to eligible small businesses for various business purposes, such as commercial real estate loans and more.
• 7(a) Working Capital Pilot (WCP) program: Grants monitored lines of credit to finance a range of needs for growing small businesses, including domestic and/or export purposes.
• 504 loans: Offers long-term, fixed-rate small business loans of up to $5.5 million to small businesses for assets that promote growth and job creation.
• Microloans: Provides smaller-sized loans of up to $50,000 to help small businesses and certain nonprofit childcare centers establish and grow their business.

Who qualifies for an SBA loan?

Generally, businesses must be creditworthy, registered for-profit organizations, based in the U.S., and meet SBA size requirements to get an SBA-backed loan. That said, each loan program has its own additional requirements.

• For 7(a) loans: Be an eligible business that tried but was unable to obtain the necessary credit on reasonable terms from a non-government source.
• For 7(a) Working Capital Pilot (WCP) program: Have at least one year of operating history and can produce timely and accurate financial statements, billing and invoicing documentation, and inventory reports.
• For 504 loans: Have qualified management expertise and a feasible business plan. The tangible net worth of the two prior years is less than $20 million, and the average net income is less than $6.5 million after taxes.
• For microloans: Depends on the intermediary lender. However, microloan lenders generally require some type of collateral and a personal guarantee from the business owner.

SBA loan pros and cons

While they aren't for every business, there are many benefits to applying for an SBA-backed loan.

SBA loan pros

• Longer repayment terms for some loans (up to 25 years for real estate construction or improvements and 10 years for other assets)
• Lower interest rates on average due to government backing
• Higher loan amounts available
• Comparable rates and fees to non-guaranteed loans
• Continued support to help you start and run your business
• Lower down payments on average compared to non-guaranteed loans
• Flexible requirements on how much a business needs to spend on overhead costs to qualify
• No collateral needed for some loans

SBA loan cons

• Longer approval process due to detailed documentation and SBA involvement
• Stricter eligibility requirements mean not all businesses qualify
• Some long-term loans have prepayment penalties 
• Must first exhaust non-government loan options

What is a business line of credit?

Rather than providing one large lump sum, a business line of credit allows companies to draw funds up to a predetermined limit, as needed. In this way, a business line of credit is actually more similar to a business credit card than a loan. Additionally, borrowers only need to pay interest on the amount used, not the full available sum.

Depending on the lender's policy, businesses can access these funds from a business checking account, checks, bank transfers, or cards linked to the line of credit. There are both secured and unsecured lines of credit depending on the size of the available sum. A larger sum may require you to secure the line with collateral.

A business line of credit also differs from an SBA-backed loan in that companies often use it to manage business finances rather than for one specific purpose or purchase. 

Who qualifies for a business line of credit?

Requirements vary lender to lender. That said, many lenders will require businesses to have consistent revenue, strong cash flow, a detailed business plan, and a good credit score to qualify. Some lenders may also limit eligibility to businesses that have been operating for a fixed amount of time. 

Business line of credit pros and cons

Like SBA loans, business lines of credit come with their own unique benefits and drawbacks that may influence whether or not the financing option is right for your business. 

Line of credit pros

• Provides access to funds when required, offering a more flexible financing option
• Accrues interest on the amount drawn only, not on the full limit
• Finances various short-term needs, such as managing cash flow or covering unexpected expenses
• Offers revolving credit, meaning that once you repay the funds, the line of credit replenishes
• Doesn't require collateral for unsecured lines
• Tends to offer lower interest rates than business credit cards

Line of credit cons

• Variable interest rates, which can lead to fluctuating repayment amounts
• Typically lower credit limits compared to term loans
• May require collateral, depending on the lender's terms
• Often unsecured lines of credit have higher interest rates than secured lines 

How to choose which financing option is right for you

When determining which financing option is right for your business, it's helpful to consider the following factors.

• Financial needs: Assess whether the funding is for a one-time, substantial investment or recurring, short-term expenses.​ If you need a large lump sum for a one-time expense, an SBA loan is better. If you need long-term funding that you can access as needed, a business line of credit is better.
• Repayment ability: Consider your business's cash flow and whether you'd prefer predictable payments or the potential of lower rates.​ SBA loans—such as the 504 loan—tend to have fixed interest rates, while unsecured business lines of credit tend to offer variable rates.  
• Eligibility: Evaluate your business's ability to meet the specific requirements of each financing option. While eligibility varies, a business line of credit may have more lenient size and credit requirements compared to an SBA-backed loan.
• Creditworthiness: Depending on your financing needs, maintaining a business line of credit in good standing may help you build your credit rating to prepare for buying an SBA-backed business loan in the future. 

No matter which financing option you choose, LegalZoom can help you meet eligibility requirements and strengthen your application through various services, including patent or trademark registration.

If you still have questions about which route is best for your business, reach out to a business attorney for legal advice based on your unique circumstances.

FAQs 

How long does it take to get approved for an SBA loan vs. business line of credit

The approval processing time varies by lender for both an SBA-backed loan and a business line of credit. That said, approval for an SBA loan tends to take 5-10 days just to review your application, not including the lender approval process that can take up to a month. A business line of credit can take anywhere from several days to a few weeks. 

What documents do I need to apply for an SBA loan or a business line of credit?

Both financing options typically require formation documents as proof of your business' legal structure, ownership information, your EIN, and various financial statements. 

What are the interest rates for SBA loans vs. business lines of credit?

For both SBA-backed loans and business lines of credit, interest rates depend on the lender and program. The 504 loan program offers fixed-rate loans, 7(a) loans and microloans can be either fixed or variable. Microloans are generally between 8%-13%. 

What are the interest rates for SBA loans vs. business lines of credit?

For both SBA-backed loans and business lines of credit, interest rates depend on the lender and program. The 504 loan program offers fixed-rate loans, while the 7(a) loans and microloans can be either fixed or variable. Rates generally range between 8%-13%.

Interest rates for a business line of credit range significantly by lender, depending on factors like the business owner's creditworthiness, size of the loan, and whether the interest rate is fixed or variable. 

Do SBA loans have lower interest rates than business lines of credit?

While it depends on a number of factors, generally SBA-backed loans can offer lower interest rates compared to business lines of credit due to government guarantees.