Line of Credit vs Term Loan
One goes up and down with your trading. The other only goes down. The bank matches each to what the money is for, and reads a request that has them backwards as a diagnosis.
BY MICHAEL SHANG · SIXTEEN YEARS IN COMMERCIAL BANKING · UPDATED
// THE SHORT ANSWER
A term loan is a fixed sum, repaid on a schedule over years; the balance only falls. A line of credit — an overdraft or a revolving facility — is a limit drawn and repaid as the business needs it, and the balance should touch zero inside the year. The bank matches each to the shape of the need: the term loan to something bought once and paid for over years, the line to a gap that opens and closes inside a trading cycle. A line carrying a permanent need is a term loan in disguise at an overdraft's price, and the desk reads it as a diagnosis.
BASIS Practitioner judgment from sixteen years in commercial banking, set out in How Bankers Think (Highbank Press, 2026). Every borrower on this site is a composite constructed for teaching, not a client. The market is mid-market commercial lending as practised in New Zealand and Australia; where a convention differs elsewhere, the page says so.
// BEFORE THE BANK READS IT
The first checks a credit desk runs — is the growth real, does EBITDA convert to cash, are suppliers carrying the gap — on twelve numbers from your own accounts, with the senior banker's written read. Free, no signup, no data stored.
// 01 — TWO SHAPES OF DEBT
Draw a term loan on a chart and it is a staircase going down: a sum advanced once, repaid in instalments, gone at maturity. Draw a line of credit and it is a wave: a limit the business draws into as suppliers are paid and stock is built, and climbs out of as customers pay, with the room restoring itself every time. The bank sells both, and it sells them for different needs, because the shape of the debt is meant to follow the shape of the thing being funded.
Line of credit · a limit, not a loan · drawn and repaid at will · for a gap that opens and closes · the balance should touch zero inside the year
“Line of credit” covers two products on a commercial desk. The overdraft is a limit on the trading account, priced daily on whatever is overdrawn, and repayable on demand — built for days and weeks of timing noise. The revolving credit facility is the same idea made formal: documented, committed for a term, sized to a business's trading cycle, with a clean-down test that requires the balance to return to zero for a period every year. The term loan file covers the other shape.
// 02 — MATCH THE DEBT TO THE NEED
The rule the desk applies is older than any product: fund a need with debt that comes back the way the need does. A machine earns its cost back over years, so it is funded over years, on a term loan whose repayments sit inside the cash the machine helps produce. A season's stock is sold within months, so it is funded on a line that is drawn to buy it and repaid when it sells — the self-liquidating loan, the oldest kind of bank lending there is, and the shape of the Kowhai file, where a seasonal line is meant to be back at zero by the end of February.
The diagnosis that decides which you need is the one in Temporary or Permanent Working Capital: how much of your working capital is a wave, and how much is a floor the business never gets below. The wave is a line. The floor is not — it is permanent capital, and it belongs on term debt or on equity, because a line asked to carry it will never touch zero. The cash conversion cycle gives the size of the wave; the standing level of stock and debtors gives the floor.
// 03 — WHAT EACH ONE COSTS, AND WHY
A term loan is priced on one rail: a margin over the bank's cost of funds, on the balance outstanding, with the rate usually the lowest in a business's stack because the risk is fixed the day it is drawn and falls as it amortises. A revolving line is priced on two rails: a margin on what is drawn and a commitment fee on what is not, because the bank holds capital against the whole promise whether or not it is used. An overdraft is priced daily on the overdrawn balance, at the highest rate in the stack, because the bank is selling convenience and can withdraw it. Pricing and Fees sets out the components from the borrower's side; How Banks Price a Business Loan from the desk's.
So the honest comparison is not rate against rate. A line is more expensive per dollar drawn and cheaper per dollar of need, because it is only drawn when the need is there; a term loan is cheaper per dollar drawn and dearer if the money sits idle in the account waiting for a season. Match the shape and each is cheap. Mismatch it and each is dear.
// 04 — HOW THE DESK READS A REQUEST
A credit analyst reading a line request looks for the wave. Do the management accounts show a cycle — stock building, then debtors, then cash? Does the season the borrower describes appear in the numbers? Would the balance, on those numbers, return to zero at some point in the year? If yes, the line is the right instrument and the size follows from the cycle. If the numbers show a need that never closes, the desk is looking at hardcore debt in a line's clothing, and the honest answer is a term loan for the floor and a smaller line for the wave — or the question of whether the business needs equity.
Reading a term loan request, the desk looks for the life and the cover: an asset or purpose that outlasts the loan, and cash after all other commitments that covers the repayments through a bad year, not an average one. A term loan for something that will be sold within months, or a line for something that will still be there in five years, tells the desk that the business has not diagnosed itself — and a working capital request is read as much for that diagnosis as for the number on it.
// 05 — THE MISTAKES, IN BOTH DIRECTIONS
The line that never touches zero. A business buys a machine, or absorbs a bad year, or lets its debtors stretch, on the overdraft. The balance stops oscillating. The clean-down fails. The business now has a term loan at an overdraft's price, repayable on demand, and the bank's annual review becomes a conversation about what the line is really carrying. The term loan for a season. Less common, and less dangerous, but a business that funds its Christmas stock on a five-year loan is paying interest for eleven months on money it needed for one. The line as a substitute for equity. The most serious: a growing business whose permanent working capital rises every year and is funded, every year, by a slightly larger line. The bank reads that as a business growing on its lender's capital, and at some review the line stops growing — Issue 01 is that review: a revolver asked to grow while debtors stretch and stock doubles, and a senior banker who declined it.
// 06 — SO WHICH ONE
Ask what the money is for and how it comes back. If it comes back inside a trading cycle, a line, sized to the cycle. If it comes back over years, a term loan, shaped to the life of what it bought. If you cannot say which, the bank will find out for you at the review, and it is better to have done the diagnosis first — the application guide shows what a request that has already matched the debt to the need looks like on a desk.
// QUESTIONS PEOPLE ASK
- What is the difference between a line of credit and a term loan?
- A term loan is a fixed sum, advanced once, repaid on a schedule over years; the balance only goes down. A line of credit — an overdraft or a revolving facility — is a limit the business draws on and repays as it needs, and the room restores itself after every repayment; the balance goes up and down. The bank matches each to a different kind of need: the term loan to something bought once and paid for out of years of earnings, the line to a gap that opens and closes inside a trading cycle.
- Is a line of credit cheaper than a term loan?
- Usually not on the rate, and the comparison is not really about rate. A line is priced on two rails — a margin on what is drawn and a commitment or line fee on what is not — and an overdraft carries the highest rate in most businesses' borrowing stack. A term loan's rate is typically lower because its risk is fixed on day one and falls as it amortises. What a line saves is interest on money you would otherwise hold idle, which is why it wins for a fluctuating need and loses for a permanent one.
- Can I use a line of credit to buy equipment?
- You can, and it is one of the most common mistakes a credit desk sees. A machine is paid for out of five or more years of earnings, and funding it on a line that is meant to swing back to zero means the line never does — the facility stops touching zero, the bank's clean-down test fails, and the business has a term loan in disguise at an overdraft's price with the bank able to call it. The right instrument is a term loan or equipment finance, shaped to the asset's life.
- What does a bank look at when deciding between them?
- The shape of the need. For a line, the desk wants to see a cycle — the cash conversion cycle, the season, the timing gap between paying suppliers and collecting from customers — and a balance that would return to zero at some point in the year. For a term loan, it wants an asset or a purpose with a life longer than the loan and cash flow after all other commitments that covers the repayments through a bad year. A request for a line where the numbers show a permanent need, or a term loan for something that should be seasonal, tells the desk the business has not diagnosed itself.
- Should a business have both?
- Most established businesses do, and the split is the point. Permanent capital — premises, plant, the standing level of stock and debtors a business never gets below — belongs on term debt or equity; the seasonal and timing gap above that belongs on a line. A bank reads the mix as a diagnosis: a business whose line is carrying permanent need is under-capitalised, and a business with a large term loan and an untouched line is paying for a promise it is not using. The Temporary or Permanent guide is the test.
// RUN YOUR OWN NUMBERS
The Three Diagnostics take your cash conversion cycle, your cover and your leverage and show what a desk would see — including whether your line is carrying a floor. Free, nothing stored.
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