When American businesses need to raise money, loans and credit cards are by far the two most popular approaches. The 2019 Small Business Credit Survey conducted by the Federal Reserve banks, which includes 6,614 responses from small employer firms with 1–499 full- or part-time employees in the U.S., asked business owners which sources of external financing they used on a regular basis. Fifty-five percent reported using loans/lines of credit and 52% reported using credit cards, while no other option scored higher than 13%.
If your business needs money, chances are you're also considering between one of these two approaches. These key differences between business credit cards and loans—along with situations when each makes the most sense—may help you with your decision.
Business Credit Card vs. Loan Overview
With a business loan, you get a lump sum of money up front that you can use for business purposes. The lender will then set up a repayment schedule, like monthly payments over five years, and charge interest throughout this time.
Business credit cards are more flexible. Your business receives a maximum borrowing limit and you can spend as little or as much as you want up to the limit. You can then pay off your balance and spend back up to the limit again. The credit card will not charge interest if you pay off your debt before the statement date, but will if you still owe money past that point.
Advantages of a Business Loan
- Can be for larger amounts of money. Even small-business loans can be for six or seven-figures. For example, loans through the Small Business Association can go all the way up to $5 million.
- Allows a long repayment schedule. You can set up a business loan that lasts for years or even decades so you have more time to pay off a large debt.
- May charge a lower interest rate. Since business loans can have a tougher approval process and are for a longer amount of time, they typically charge a lower rate than credit cards.
Disadvantages of a Business Loan
- Tougher approval with more requirements. To qualify for a bank loan, you may need to provide your tax returns, business financial statements, proof of revenue and have a strong credit score.
- Could require collateral. The lender may ask you to back up the loan with an asset, like equipment or your personal savings. If you fail to repay, they could seize your asset.
- Longer application process. You may not get a decision on your business loan application for several weeks.
Advantages of a Credit Card
- Easier and faster to take out. Since credit card companies do not ask for the same supporting documents as loans, they can make faster and sometimes instant approval decisions, depending on your credit score and other factors.
- Doesn't require collateral. Not paying your credit card debt will hurt your credit score, but the lender won't seize your property.
- Can earn rewards on your spending. Some business credit cards earn rewards like cash back when you make purchases. Loans generally do not offer rewards.
Disadvantages of a Credit Card
- May charge a higher interest rate. In exchange for being unsecured, credit cards typically charge a higher interest rate than personal loans.
- Lower borrowing amounts. Credit card maximum limits are around five figures, not as high as loans.
- Carrying a high balance can hurt your credit score. When your credit cards are close to being maxed out, you lose points on your credit score. This doesn't happen when you have a large outstanding loan.
When does a loan makes sense?
Your business is making a large, long-term investment. Let's say you're interested in renovating your building, hiring new staff, expanding to a new location or buying new equipment. These are all greats fits for a loan.
These investments usually take more money than you can get through a credit card. It also can take time for these investments to generate a profit so they match up better with the longer payback period on a loan. As an added benefit, when you buy equipment and property you automatically create loan collateral to help your chances of qualifying.
Both business loans and credit cards can play a role in your financing plan. Just make sure to use the right tool for the job.
You can wait on receiving your money. Since some business loans have a relatively long approval period, your business can't be in a rush to get the money. But for projects that will take a few months to launch, like opening a new location, you can afford to wait until the financing is ready.
You need time to pay off your debt. Loans are a better fit for long-term borrowing. Not only do loans charge less interest, owing a large amount will not hurt your credit score so long as you make the monthly payments.
When does a credit card makes sense?
You're looking to cover working capital needs. A business credit card can help offset the swings of your cash flow. If a client is late on paying an invoice or your business needs to make emergency repairs, you can use your credit card to immediately cover the bill. In these situations, there isn't time to apply for a loan.
You want to cover small transactions that you'll pay back quickly. Whether it's paying your utility bills, covering travel expenses or processing your monthly advertising spend, with a business credit card you can automatically cover these small bills and then pay them back once you have the cash. You'll also earn rewards on your purchases at the same time.
You're looking to build your business credit history. If your business is relatively new or you still need to build up your credit history, it's easier to do so with a credit card. You may be able to open an account just through your personal credit history and then you'll build up your business credit by paying your monthly statement.
Both business loans and credit cards can play a role in your financing plan. Just make sure to use the right tool for the job. By keeping these situations in mind, you can figure out which strategy makes sense at any given time.
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