Small businesses have several options when it comes to securing funding for to help grow and support their enterprises. While many entrepreneurs opt to go the small-business loan route, that isn’t a great option for either short-term or ongoing expenses. Not to mention, it can often take months to get approval for a bank loan, and requires jumping through hoops and a great deal of paperwork.
The good news is that there are other options, and two popular ones are credit cards and lines of credit. Many entrepreneurs confuse the two, though, even though they aren’t quite the same thing. It’s actually more accurate to say that they are both types of credit, and each has its own advantages and disadvantages when it comes to financing your business.
Understanding the Difference
To start, let’s explain the difference between a business line of credit and a business credit card.
Most of us are familiar with credit cards. Cards are a revolving source of credit; in other words, you have a set limit of how much you can spend, which is influenced by your balance. As you pay the balance, the credit becomes available to spend again. You pay interest on your balance (unless you pay within the grace period, depending on the card) and may have access to features such as rewards programs, purchase protection, travel insurance, and other perks.
A business line of credit is somewhat of a hybrid of credit cards and loans. The lender sets a credit limit (often much higher than you might get with a credit card) that you can borrow against, and you pay interest when you borrow money. There are two types of credit lines, secured and unsecured. A secured line of credit is backed by some sort of collateral, whether physical property, your businesses invoices, or other assets. Unsecured credit lines aren’t attached to any assets, and are granted based on your income, credit history, etc.
While there are benefits to both types of credit – business owners often appreciate the rewards that can come from using credit cards, for instance – you should know the pros and cons of each before determining which is right for a situation.
Weighing Your Options
While credit cards have their benefits, such as rewards programs, they do present some limitations for business owners. For starters, they often come with higher interest rates than other types of funding, and there is little to no flexibility with payments: You must pay at least the minimum amount due every month to keep the account in good standing.
Credit cards also have limitations on cash advances (usually up to 20 percent of the total credit limit) and charge more to access cash. However, they are useful for smaller, short-term expenses that you can pay off quickly, building both your business’s credit profile and your rewards balance.
A line of credit, on the other hand, is ideal for those times when you need to access cash quickly. Overall, the interest rates on lines of credit tend to be lower than credit card rates, and there are fewer fees. In fact, you can usually borrow up to the full amount of your available credit with minimal fees. Repayment terms are worked out on a case-by-case basis; in some cases, you may be able to work out a more flexible payment plan than you might otherwise have with a credit card.
On the downside, credit lines are, in many cases, non-revolving, meaning that even when you repay a “loan,” that amount does not return to your available balance. For example, if you have a $20,000 line of credit and borrow $5,000, your available credit remains $15,000, even after you repay what you borrowed. This isn’t always the case, but it’s important to understand the difference. It can also be more difficult to qualify for an unsecured line of credit than a credit card, but they are also a good way to build your company’s credit profile
In the end, the choice about which type of funding is “better” depends largely on your business’s needs, credit history, and goals. If you need to make a significant purchase to grow your business – extra inventory for your store, for instance – a line of credit is likely to be a better choice. If you are buying lunch for the crew, or supplies for the break room? A credit card is usually better. In either case, don’t limit yourself to loans or a single option, but explore the different sources that are available.