Which should you choose? Business credit cards vs. business loans

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Which should you choose? Business credit cards vs. business loans


Do you want to start a business or need more money to fund your current business?

Many business owners use either a business credit card or a business loan for their capital needs -- but which is best for you? Here are some pros and cons of each option.

Business credit cards versus business loans - the big differences

Here are some general differences you should know before deciding between a business loan and credit card.

  • When applying for a business loan, you may need to show more documentation than is required for a credit card application. During the loan application process, you may even need to share references or show that you have a personal history in the relevant industry.
  • A business loan gives you easier access to cash, which is important if you need to pay your employees or you work with a vendor that doesn't accept credit cards. You may be able to take out a cash advance from the credit card but this can incur hefty interest charges.
  • Business credit cards offer you a revolving line of credit. In other words, the credit limit is the maximum that you can use at once, but the credit can be used over and over again. In contrast, a business loan offers a fixed amount of money that you pay off in installments. Once you repay the loan, you'll have to apply for a new loan if you need additional funds.
  • Business loans may charge origination, early repayment or underwriting fees, and have additional closing costs. For example, Wells Fargo charges a $150 documentation fee ($250 for lines over $25,000) while Bank of America charges 0.5 percent of the amount loaned plus additional fees based on the amount of money borrowed and type of loan. Business credit cards may charge an annual fee of around $100 or less, a set amount regardless of how much is charged on the card. However, you may incur other fees such as late payment fees.
  • Credit cards are often unsecured, meaning you don't offer anything as collateral in case you can't pay the debt back. However, many business credit cards require the applicant to sign a personal guarantee that makes them personally liable for the debt. This means that if your company goes bankrupt, the credit card provider can go after your personal assets.
  • Business loans are often secured or guaranteed by assets, such as a building, inventory, equipment, vehicles or a certificate of deposit at the issuing bank. Some business owners even use their personal property as collateral. Keep in mind that you might consider your property or inventory more valuable than the lender does and may not be able to borrow as much money against it as you thought.

Business credit cards - pros and cons

There are several reasons you may want to consider using a credit card for your business's ongoing expenses.

First, you can easily separate business and personal purchases by putting all your business's purchases on the business card and saving your personal cards for other purchases. This can be useful during tax season.

Business cards also usually offer a number of benefits to business owners, such as bookkeeping, expense tracking, employee cards, rewards programs, exclusive savings programs and purchase protections such as extended warranties.

In addition, using a business card responsibly -- keeping the balance low and repaying on time -- can help you build business credit, which is separate from your personal credit. This, in turn, can make securing financing easier in the future.

According to a September CreditCards.com report, the average interest rate on a business credit card is 12.85 percent. Short-term loans, on the other hand, may have higher interest rates and could be costly, especially once the fees are taken into consideration. Online business lender OnDeck offers six-month loans that have an average interest rate of 17 percent, plus an extra 2.5 percent of the amount loaned to first-time borrowers. Lending Club advertises a minimum interest rate on business loans of 5.9 percent; however, you'd need to be a top-tier borrower in order to qualify for this rate.

On the other hand, missing a single credit card payment or spending more than your credit limit can result in a penalty rate of nearly 30 percent - which can be applied toward the total balance inclusive of past charges.

Also, you can't use a credit card to pay employees without taking out an expensive cash advance.

Business loans - pros and cons

If you're in need of a lot of capital, a business loan is often the best option. Even small businesses can be approved for loans of several hundred thousand, or even several million dollars. In the world of business loans, a microloan is generally considered to be $50,000 or less.

The interest rate can also be much lower on a long-term business loan than a credit card. For example, the maximum SBA fixed-rate guaranteed loan has an APR of 9.84 percent. However, loan issuers may charge additional fees, including early-repayment fees.

One of the biggest challenges when it comes to securing a small business loan is getting approved. In 2014, a study by the Federal Reserve Banks of New York, Atlanta, Cleveland and Philadelphia found that while 54 percent of loan applicants were approved, only 33 percent received the entire amount requested.

When applying for a business loan, you may need to provide the following:

  • Your personal and business credit scores and reports.
  • A business plan or marketing plan.
  • References from friends, colleagues, clients or vendors.
  • A profit and loss statement.

The lender may also want to know your personal history and your experience in the industry. In addition, similar to a business credit card, the lender might request that you sign a personal guarantee for the loan.

Choosing a small business lender can be challenging. Major banks, regional banks, credit unions, the Small Business Administration, online lenders and peer-to-peer lending platforms all offer business loans. You may want to narrow down the options by figuring out which lenders offer loans of the size and time frame you need, then shop around to find the best terms.

Bottom line

For short-term needs, a business credit card can be the quickest and cheapest option. Even if you don't need the money, using a business credit card for day-to-day expenses can be wise because of the associated perks.

Small business loans are typically harder to obtain, but can be a good option if you need cash to pay employees or have major expenses to pay. Online business lenders often make the application process easier, but may charge a premium for their services.

About the author: Louis DeNicola is a personal finance writer and educator. In addition to being a contributing writer at Credit Karma, you can find his work on MSN Money, Cheapism, Business Insider and Daily Finance. When he's not revising his budget spreadsheet or looking for the latest and greatest rewards credit card, you might spot Louis at the rock climbing gym in Oakland, California.

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