All small business owners need a certain amount of capital to open their doors, keep them open, and pursue new opportunities. With so many options on the table, it’s critical to explore the pros and cons of each one. Here’s a look at two of the most popular: credit cards versus business lines of credit.
Small Business Credit Cards vs. Lines of Credit
Types of Credit
The largest similarity between small business credit cards and lines 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 revolving lines 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 moniker “revolving”.
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 do not take credit scores into account, making these loans potentially easier to access for small business owners with less than perfect credit. Instead, lenders harness multiple data points – ranging from seller ratings, to social media engagement, to sales numbers, to bank account records, and much more – to determine your creditworthiness.
Once a credit card application is accepted, it typically takes a few weeks for the credit card company to print and issue the card. However, in some cases, credit card processors can rush the printing process and overnight the card to the recipient. In contrast, lines of credit are funded within a day or two after approval, and to access the funds, you simply transfer them to your bank account.
Interest and Fees
Credit cards charge varying interest rates, but one study indicates that the average APR for credit card debt is 21 percent. Some borrowers face penalty rates up to 33 percent or higher. Additionally, credit card companies often charge late fees and over-the-limit fees that may be higher than $30. In contrast, the interest rates on a small business line of credit from Kabbage range from 1 to 12 percent per month, and there are no fees for early repayment.
One of the biggest complaints about credit cards is that they lock consumers into debt. In particular, this tends to happen when the borrower only makes the minimum payment every month. Credit card providers often charge only a percent or two of the total balance as the minimum payment, and if a borrower pays this amount, he may take decades to pay off just a few thousand dollars in debt.
To illustrate, imagine a small business owner pays $2,000 for a new computer using a credit card, the creditor charges an 18 percent interest rate, and the borrower only pays the minimum payment each month. In that case, it takes the borrower over 30 years to repay the loan, and he pays roughly $4,900 in interest and fees over the original purchase price.
Conversely, lines of credit are set up so that the borrower can actually repay the loan. In particular, Kabbage embraces a six or twelve-month repayment schedule on its loans. This type of setup encourages borrowers to repay their loans in a timely fashion, helping to inoculate their businesses against long-term, unsustainable repayment schedules.
A great deal of research has been done on how credit cards affect consumer spending habits, and it indicates that consumers are often less guarded when spending with a credit card than with cash. As a result, these consumers often end up spending more than they would if they were spending cash. Additionally, in some cases, consumers using credit cards are willing to spend up to twice as much on a product as they would be willing to if spending cash.
Unfortunately, lines of credit have not been exposed to the same level of scrutiny as credit cards, and as a result, there isn’t a lot of conclusive evidence as to how lines of credit affect people’s spending habits. However, as you can only make transfers from your line of credit to your bank account once per day, that can help with budgeting and avoiding overspending.
Accessibility to Cash
With a line of credit, once you transfer the funds to your bank, you can use them as you wish. You can write checks, use your debit card, or withdraw cash from your bank. In contrast, if you want to take cash off a small business credit card, you may face certain limitations.
Namely, some credit cards limit a certain dollar amount or percentage of the balance as cash. Additionally, it is routine in the credit card industry 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 they generally do not apply to cash advances. As a result, accessing cash is more difficult and more expensive using a credit card compared to a line of credit.
Credit cards and business lines of credit can both offer an effective way for small business owners to access funding. Unfortunately, small business credit cards can lock business owners into debt for decades, while lines of credit are set up so that they can be repaired relatively quickly. However, in some cases, business owners may prefer the small minimum payments associated with credit cards. Ultimately, the right decision depends on your unique budget and business objectives.