Business Banking

Business line of credit vs. credit card

A business line of credit (LOC) is an ongoing loan that your business can draw upon as needed. A business credit card, on the other hand, refers to a credit card that you specifically use for business

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What is the difference between a line of credit and a credit card?

A business line of credit (LOC) is an ongoing loan that your business can draw upon as needed. A business credit card, on the other hand, refers to a credit card that you specifically use for business purchases and expenses.

Both present a revolving credit facility that your business can tap into when you need some working capital. However, they are two completely different types of credit. For example, a business credit card is generally more flexible and comes with fewer restrictions compared to a business line of credit. You can use the credit card to pay bills, purchase inventory, cover expenses and so on.

Here’s a look at the difference between credit cards and lines of credit.

How does a business line of credit work?

A business line of credit is a revolving loan that a lender allows you to use as needed over a specified period of time. The lender provides a fixed amount that your business can draw whenever it’s strapped for cash and that amount is your credit line limit.

One advantage of a business line of credit is that lenders allow you to either draw the full amount at once or you can draw smaller amounts over time as needed. This differs from a traditional term loan, which is offered in one lump sum. Whatever the case, the lender will only start charging interest once you make the first withdrawal from the fund.

In addition, you don’t have to use the full amount allocated to you and you only repay what you actually used. A line of credit is different from a small business loan in this way because you have to repay the full amount of a loan, whether you used it or not.

Business credit lines have what is called a draw period. This is the amount of time (in years) that you can tap into the fund. During the draw period, you can tap into the fund as much as you want provided you don’t exceed the limit. Only the amount you use is subject to the interest rate and fees.

With regards to repayment, you can pay the full amount due at once or in bits. Any amount that you repay goes back into your pool, giving you a chance to borrow it again, which is what makes a business line of credit a revolving fund.

Business line of credit example

Say, for example, that your lender gives you a business line of credit worth $10,000. Your business can draw from that amount as long as it needs cash, however you can only draw a maximum of $10,000 because that’s the limit of your credit line.

So, if you have a $10,000 limit and draw $4,000, it means that your fund will still have $6,000 that you can borrow. Assume that you tap into the fund again and draw another $1,500. Your total value of debt will be $5,500 (calculated as 4,000 + 1,500). Your credit line will remain with $4,500 (calculated as $10,000 – $5,500). You can keep borrowing that way until you hit your $10,000 limit.

Any amount that you repay goes back into the pool and you can borrow it again. So, if you repay $2,000 when your fund has $4,500 in it, then your new fund will have $6,500 (calculated as $4,500 + $2,000).

How to get a business line of credit

Business lines of credit are provided by banks and online lenders. While banks give you the option to apply online or in person, online providers typically do everything online.

Once established, you may need to contact the lender, requesting them to transfer the money to your account. Your business can then draw from the line of credit using a debit card that’s linked to that account.

The limit on a business line of credit can be pretty high. Depending on your company’s financial health and credit history, the lender may set your limit as high as $100,000 for a small business.

A business line of credit can be secured or unsecured. Should the lender need security, then you can use your assets or financial instruments as collateral and such assets can be seized if you don’t repay your debt. 

Business line of credit requirements

Most lenders require that your business has a history of at least six months in business and $25,000 annual revenue. You can, however, qualify with a lower revenue as long as you have stellar personal credit.

Some online lenders neither consider your credit score nor your business’s credit history. They are perfect for small business owners who haven’t had the chance to build a solid credit record.

As with all types of loans, business lines of credit come with costs and while the exact list of LOC costs varies from lender to lender, you can generally expect the following:

  • Origination fee – typically ranges from 0.5% to 1% of the credit amount.
  • Draw fee – typically pegged at 1% of the amount you draw.
  • Late payment fee – typically charged when you miss a payment as set by the lender. It can be any value between $25 and $35.
  • Annual maintenance fee – typically ranges from $25 to $50.

Business line of credit rates

Like most business loans, a business line of credit comes with an annual percentage rate (APR) type of interest. Your APR may be as low as 3.25% or as high as 70%. It all depends on the lender, the amount, your credit score and whether the line of credit is secured or unsecured.

Interest on a business line of credit will only start to accrue once you draw from the fund. In addition to this, the interest is only charged on the funds that you actually use. Thus, the amount you repay is the amount of cash used plus interest accrued.

Business line of credit repayment

Your lender will often determine the minimum monthly payment of your business line of credit. This value is usually calculated as a percentage of your outstanding balance.

In case you still have a debt after your draw period, the lender may come up with an installment plan for clearing the remaining balance.

Pros and cons of business line of credit

Advantages of a business line of credit:

  • Improves cash flow when the business is not making enough money
  • Helps the business to pay bills and expenses
  • Lower interest rates than credit cards
  • Only pay interest on the amount you use
  • Can improve a business’s credit history
  • Simplifies expense tracking

Disadvantages of a business line of credit:

  • Comes with charges and fees
  • Lower borrowing limits compared to other options like loans

What is a personal line of credit?

A personal line of credit is a revolving fund from which you can borrow (up to a predetermined limit) over a specified draw period. A personal line of credit is similar to a business line of credit save for the fact that the latter is strictly for business entities while a personal line of credit is for individuals.

How does a business credit card work?

A business credit card is a card that allows a business owner to make purchases and pay bills on credit. Some credit cards do allow cash withdrawals (also known as cash advances). However, these cards are mostly for business purchases and expenses.

Thus, the biggest difference between a credit card and a line of credit is that a line of credit gives you cash while a credit card gives you the ability to purchase things and pay bills on credit. The two are similar in that both are types of revolving credit agreements.

Business credit cards work very similarly to personal credit cards; the only difference is that they are issued exclusively for business expenses. As such, your business credit card company will report your transactions to the business credit bureau and not the personal credit bureau. This is important for you as a business owner because it means that you can build your business’s credit score while protecting your personal credit record.

Since we’re talking about business lines of credit vs. credit cards, it’s worth noting that unlike a LOC, you can keep your credit card active as long as you want. Your credit card company will, however, set a limit on your account. That means you can draw from your credit card up to a certain limit. The lender will then require you to repay all or some of the money used when your billing cycle comes.

The typical billing cycle of a business credit card is 28 to 31 days. Often, credit card issuers set the minimum repayment (per billing cycle) at 2% of the balance. Any amount that you repay over that period will be availed to you again for borrowing. This revolving nature of a credit card is what makes it similar to a line of credit.

How to get a business credit card

Credit cards are issued by banks and credit unions. The easiest way to get a business credit card is to apply online via the card issuer’s website. The process takes a few minutes and you may even be approved instantly. However, it may take up to 14 days for the card to arrive in the mail.

Compared to LOCs, credit cards carry a lower limit that typically tops out at $50,000. That’s something to keep in mind when comparing a line of credit vs credit card. I.e., you’re likely to get a larger credit limit with a business line of credit than a credit card.

Business credit card requirements

Card issuers will often use your personal credit to qualify you for a business credit card. Traditional business credit cards are unsecured, which means you won’t have to put up any collateral. However, you’ll need a decent credit score to qualify for the card.

Business credit cards come with fees. Here are the most common:

  • Cash advance fee – ranges between 3% and 5% of the amount you withdraw
  • Late fee – charged when you default on a payment. It’s typically between $28 and $40
  • Over limit fee – this is charged when you exceed the set limit. It’s typically $25 to $35
  • Annual fee – may be anywhere from $0 to $500 or even more. Be sure to shop around for the most affordable business credit card.

Business credit card rates

Business credit cards have interest rates that range from 13% to 30% or even higher. That said, you can shop for a cost-saving deal. Some issuers offer a 0% interest rate for the first six or twelve months followed by a variable rate of 13% to 20%. The 0% phase is called a grace period.

It is possible to completely avoid interest charges on your business credit card by paying your balance in full, which gives you up to 55 days of interest-free float to spend. However, these grace period terms vary with card issuers. Check with yours to know how you can take advantage.

Pros and cons of business credit cards

Advantages of a business credit card

  • Offers a flexible source of credit for improving cash flow
  • You can get rewards, miles, points and cashbacks on your card for business spending
  • Some offer travel insurance as well as purchase protection benefits
  • Makes expense tracking easy
  • You can get multiple cards for management employees on the same account
  • Offers access to interest-free credit during the grace period

Disadvantages of business credit cards

  • Not all cards allow cash advances and those that do charge much higher interest rates than lines of credit
  • Not all billers and suppliers accept credit cards
  • Issued based on your personal credit, not your company’s

Should you have a business line of credit or a business credit card for your business?

It all depends on your business needs.

For one, you typically get a higher limit with a business line of credit than a credit card. As such, you may need a LOC when the business needs to finance high-value purchases and expenses.

A line of credit is also more suitable if most of your billers and suppliers don’t accept credit cards. It’s also ideal if you prefer to make payments using checks and cash.

Finally, there are certain payments that you can’t make using a credit card. These include payroll, property leases and certain invoices. In such cases, it makes more sense to use a business line of credit.

On the other hand, a business credit card makes more sense if you want the business to earn cashbacks and travel rewards. Plus, business travelers get to enjoy protection benefits, insurance and lost luggage claims when they purchase tickets with business credit cards.

The same goes for equipment purchases. Your business credit card may offer an extended warranty, insurance and even refund options for business purchases.

And if that’s not reason enough, you can enjoy interest-free credit when you use a business credit card, offering an excellent opportunity for cheap financing.

Both options have their benefits. Also keep in mind that a business line of credit and a credit card can coexist. Look at them as financial tools that complement each other.

You can use a business line of credit to finance purchases that a credit card can’t, and vice versa. With proper debt management, your business can get interest-free credit on a credit card, a high borrowing limit on a line of credit, and a better credit score over time.

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