As a business owner, you may be wondering what the difference is between a business loan and a business credit cards. Do you need both? When should one of them be used?
Think of business lines of credit and business credit cards as financial siblings. They share many of the same features but are two separate products. They get along very well.
How does a business loan work?
A business line of credit (LOC) is a fixed amount of money you can borrow from a bank. LOCs can be unsecured or asset-backed. You have a drawing period, me. H. The number of years for which you must draw down your funds. During this time, you can withdraw as much as you like until you reach your credit limit, and only the borrowed amount is subject to financing charges. To access funds, you typically use a company checking account, credit card, or mobile app.
Lenders calculate minimum monthly repayments, which can be calculated as a percentage of the outstanding balance or based on interest. If the debt remains after the drawdown period expires, the lender determines the instalments needed to repay the debt based on the term (such as three or five years).
As with all financial products, there are costs. Depending on the lender, the LOC may include:
- Origination fee: Application processing fee, usually between 0.5% and 1% of the credit limit
- Annual Maintenance Fee: Typically $25-50 per year
- Withdrawal Fee: Usually 1% to 2% of the amount you withdraw
- Late fees: Varies by lender
- Interest rates: APRs vary widely, from the lowest rate plus a fraction to nearly 30%, with no interest-free grace period
How do business credit cards work?
Business credit cards are similar to personal credit cards, but are designed for small business owners. Most of these cards are insecure, although there are some secure business cards on the market. Like business LOCs, they have a fixed limit and you can top up to that amount if needed. Only revolving debt is assessed as a financing charge. Unlike LOC, you can keep your account active as long as you want.
Credit card issuers calculate a minimum monthly payment, usually 2% of the balance (unless the balance is as small as a fixed amount, such as $25). You can use the card to make purchases and withdraw cash.
Regarding fees, here are a few things:
- Annual Fee: Some cards have no annual fee, while others cost more than $500
- Late fee: Typically $39 to $41 after the first late payment, some cards charge 3% of the overdue amount (whichever is higher).
- Cash Advance Fee: Typically $5 to $15 or 3% of the amount (whichever is higher)
- Over-limit fee: up to $35
- Interest: Variable APR typically between 14% and 26% (excluding 0% APR introductory offer), no interest charged on purchases other than cash advances during the grace period
Business credit cards typically have a credit limit of around $50,000.
Line of Credit and Credit Cards
Because the limit can be so high, a business LOC is often used to finance short to medium term financing for expensive items that you plan to pay for over time. For example, you might need $50,000 worth of restaurant equipment. If your credit card has a $25,000 limit, you’re out of luck, but LOC will do it for you.
On the other hand, you may only need to spend an extra $1,000 on advertising to pay your bill within 30 days. Business credit cards offer you an interest-free grace period. Or, if you’re on a 0% credit card, you’ll have more time to charge without adding interest on your balance.
Small business incentives also need to be considered. While some commercial LOCs offer incentive programs, many do not. Business credit cards almost always do this. If you’re flying across the country or around the world, choosing a good business travel card may be your best option. They are full of benefits and can reduce these costs while offering compelling benefits.
Note that business LOCs can be more difficult to qualify than small business credit cards because they tend to offer high limits.
At the end of the day, business lines of credit and business credit cards are compatible products. Once you understand the differences between them, you can decide which one is best for your business needs. Perhaps the right strategy for your business is to use both: a business line of credit and one of the best business credit cards. With both options, you only pay interest on the funds you use.