When to Use a Small Business Line of Credit vs. Credit Cards
All small business owners need a certain amount of capital to keep their doors open and pursue new opportunities. With so many variables, it’s critical to explore the pros and cons of different types of small business funding options. Here’s a look at two of the most popular types: a small business credit card vs. a line of credit.
Differences between a line of credit and a credit card
Both a line of credit and credit card are types of revolving credit, meaning you’re approved up to a certain amount of accessible credit. You can borrow or spend up to this limit whenever you want, and you can keep borrowing funds as long as you repay the principle.
The main difference, however, is that with a credit card, you borrow money by making purchases or through a cash advance — with a line of credit, you withdraw cash whenever you need it. Both a line of credit and credit card can come in the form of secured or unsecured loans, although credit cards may include interest rates higher than a loan withdrawn from a business line of credit.
There are also other major differences between both types of funding, as outlined below.
When you apply for a credit card, the institution extending credit looks closely at your credit reports, credit scores, and several other factors indicating your creditworthiness. With a line of credit from a platform lender, however, the process is slightly different.
Platform lenders typically look at factors beyond just credit scores, making a line of credit potentially easier to access for small business owners with less than perfect credit. Online lending platforms will consider multiple data points — ranging from linked business accounts to sales numbers and bank account information — to determine your creditworthiness.
Interest Rates, Limits, and Fees
Credit cards charge varying interest rates. According to the Federal Reserve, the average APR for credit card debt is 15.13 percent as of May 2022. This rate may be on par with small business loans. However, some borrowers may face penalty rates up to 33 percent or higher if card holders are 60 or more days late on payment.
By contrast, the interest rates on a small business line of credit can have a similar range, and typically do not have fees for early repayment. Late payment fees may vary, which are important to understand when considering any credit product.
With a line of credit, once you transfer the funds to your bank, you can use the funds to help grow your business. You can write checks, use your debit card, or withdraw cash from your bank. Compare this to using a card: if you want to withdraw cash using a small business credit card, you may face certain limitations.
Some credit cards impose limits of a certain dollar amount or percentage of the balance as cash. Additionally, it is routine for credit cards to start charging interest on cash advances immediately. For example, some cards offer low introductory interest rates, but those typically only apply to purchases or balance transfers and not to cash advances. As a result, accessing cash may offer less favorable terms than a business line of credit.
Is it better to have a line of credit or credit card for business?
Both types of funding options have advantages and disadvantages, and most businesses will have both to cover certain expenses depending on the need. Though, there are certain circumstances when one option may work better than the other.
Whether you choose a line of credit or a credit card, you can qualify for a secured or unsecured account depending on your credit profile. With either a secured credit card or line of credit, you may need to put down some form of collateral, whereas with an unsecured account, you don’t.
Of course, the option you choose may depend on which one you qualify for. If your credit score is on the lower end, you may only qualify for a secured credit product. If you can raise your score, you can apply for another type of revolving credit, whether that’s an unsecured credit card or line of credit.
When to use a business line of credit
If your business is mostly going to carry a balance on a credit card, then it may be advantageous to use a business line of credit. That’s because small business loans are designed to carry a balance over several months, some up to 18-months or more. Whereas credit card balances are best if paid soon after becoming due.
A line of credit is also usually the better fit when you want to pay for bigger expenses or need capital to cover expenses that are typically not able to be covered with a credit card, which may include:
- Provide a cash bonus for new hires
- Covering payroll via bank ACH
- Covering business lease payments or mortgages
- Suppliers or business costs that request payment via cash, check or ACH
When to fund a business with a credit card
A business credit card can help cover smaller expenses and purchases that don’t require cash payments. For instance, if you’re paying for travel expenses on an upcoming business trip for multiple employees, you will need a credit card to secure a hotel room and check-in to cover for possible incidentals.
Depending on your credit card, you can also earn rewards, such as cash back bonuses or travel rewards for qualifying purchases.
A credit card can help with short term cash flow, since it provides a grace period before your balance is due and interest accrues. If you can manage to pay off the entire balance by your statement due date, you won’t have to pay any interest.
Credit Card or Line of Credit: Which is right for your business?
Credit cards and a business line of credit are both effective tools for small business owners to access funding. Many businesses use both to cover various expenses, which can be a powerful pairing.
The important thing to analyze is the type of payment, how much you need to cover the expense, and how much time you need to repay it.
Business Line of Credit vs. Credit Card: FAQs
Is a business line of credit a credit card?
No, a business line of credit is not a credit card. However, they are similar. The main similarity between small business credit cards and a line of credit is that they fall into the same credit category. Namely, they are both revolving loans, which exist in contrast to installment loans.
With a revolving line of credit, the creditor sets a spending or credit limit. You, the borrower, may spend up to that limit or spend nothing at all. When you repay the amount you have spent, you can then re-spend the funds, repay them, and spend them again, hence the term “revolving.”
Is a line of credit a good idea for a small business?
Any small business that’s looking to improve their cash flow or wants to invest in their business will likely find that a line of credit for a small business can help them reach these goals. Businesses can get access to funding on an as-needed basis up to their approved credit limit, and in most cases, can pay it back earlier with no prepayment penalties.
A line of credit is straightforward to understand and use — the application process can take minutes, and businesses can receive a decision quickly. Plus, you have the flexibility of repayment terms with straightforward rates.