Business Financing: Should You Take Out A Loan, A Credit Card, Or A Line Of Credit?

When it comes to business financing, merchants have many options to choose from. Three of the most popular sources of financing are small business loans, business credit cards, and lines of credit. All are useful options, but each carries its own separate advantages and disadvantages.

Which is best for your business financing needs: a business loan, line of credit, or business credit card. Or should you get some kind of combination of the three? Keep reading to learn everything you need to know.

Loan, Credit Line, & Credit Card Uses

Your ultimate intention for borrowed funds is very important when considering the right type of financial product for your business. While there is a lot of overlap, some financial products are better suited to different situations and uses than others.

Here is a table illustrating what each loan or credit card is typically used for:

Small business loans are a very popular financing option, and it’s easy to see why — they can be used for many business purposes, such as asset purchasing, business growth projects, and debt consolidation or refinancing. However, there are times when lines of credit or a business credit card are better options for your business.

In particular, lines of credit and credit cards are better for situations where you need money quickly or need only a small sum of money. While you wouldn’t take out a business term loan without a fair amount of planning and a fairly long application process, lines of credit and business credit cards are designed so that you have the cash available when you need it; they are better for cash flow problems, emergency funds, and other situations where you don’t have time to apply for a business term loan.

Credit cards have an additional advantage because you can use them to solve cash flow problems by deferring everyday payments to a later date. And, because credit cards offer rewards programs for using the card, you might be able to save a little money via cash back or points simply by using your card.

Naturally, however, there are many overlaps between potential uses for these three types of financing — all are commonly used for working capital and other cash flow needs. You’ll need to consider the scope of your project, as well as the following advantages and disadvantages of each financial product, to decide which is best for your business.

Small Business Loan Pros & Cons

Small business loans are usually installment loans (also called “term loans”), but might also be short-term loans. Loans are dispersed as one lump sum, and repaid in installment over a set period of time.

Loans usually involve high borrowing amounts and lower rates than other options, but they also have long application processes and you might have to pledge a personal guarantee, lien, or other assets in exchange for funding.

Pros

• High Borrowing Amounts: If you need a large amount of money, a small business loan is your best bet. At a minimum, small business lenders will offer 15% to 25% of your annual revenue, but many lenders are willing to offer more. The size of your loan will depend on your annual revenue and projected revenue, your intended use of proceeds, the creditworthiness of your business, and other factors.
• Low Rates: Some business loans, such as those offered by a bank or the SBA, will have lower rates of borrowing than credit cards. For example, while credit cards have APRs from 10% to 25% or higher, interest rates for a 7(a) loan from the SBA currently range from about 6.7% to 9.75%. That said, some online loans will have higher fees; use our Small Business Term Loan Calculator to calculate the APRs (and other borrowing metrics) on your potential business loans.
• Longer Time To Repay: Business term loans carry longer times to repay than lines of credit and business credit cards. Some loans, such as some SBA loans, carry term lengths up to 25 years. For this reason, small business loans can carry small incremental payments, even if you are borrowing a large sum of money.
• Unsecured & Secured Options: Businesses with collateral can leverage it to borrow money with very low interest rates. On the other hand, if you don’t have specific collateral, you will still be able to find a business term loan; the fees will be a little higher than they would be with a secured loan, but you will still have the money you need to grow your business.

Cons

• Long Application Process: Business term loans tend to have a more detailed application process than credit cards. You will need to submit a fair amount of documentation and spend some time talking to an underwriter before you’re approved for a loan. Non-traditional online loans tend to have shorter application processes, but you will have to pay higher rates and fees. The application process can take anywhere from a few days to a few months, depending on the lender you’re working with. As a general rule of thumb, the longer the application process, the better rates and fees you’ll receive.
• Long-Term Debt: While a small business loan generally entails smaller payments than other options, it also means that you’ll be paying your debt off for a long time. Outstanding debt might make it more difficult to find financing in the future, and you risk not being able to pay it back if something goes wrong with your business.
• Blanket Liens & Personal Guarantees Required: While you can find loans that don’t require you to put up specific collateral, you’ll likely have to sign a personal guarantee and/or agree to have a blanket lien placed on your business assets.

Head over to our guide to installment loans for more information on small business loans.

Line of Credit Pros & Cons

When you gain access to a credit line, you’ll be able to draw from a sum of money, up to your available limit, at any time — no application required. You only have to pay interest on the amount that you borrow, and once it’s repaid, you’re free to borrow that money again.

Despite the benefits, lines of credit carry some drawbacks: the initial application can be somewhat time-consuming, and if you have variable interest rates they could change over time.

Pros

• No Application To Borrow: After you gain access to a credit line, you will not have to go through an application process whenever you need funds. Typically, you’ll receive access to requested funds between a few hours and two days, depending on how your lender transfers funds.
• Low Rate Of Borrowing: Lines of credit have very affordable rates and fees. In general, these will be lower than credit card rates and fees, and might even be lower than those of many small business loans. As you might expect, however, some online lines of credit will carry higher fees than you would be charged by a bank, credit union, or the SBA. To get an idea of what sort of rates you can get from online lines of credit, which have shorter initial application processes but might have higher rates and fees, check out a comparison of our favorite business credit lines.
• Only Pay Interest On Borrowed Funds: For most lenders, you will only have to pay interest on the money you have withdrawn from your credit line. You will not have to pay interest on the funds you are not using.

Cons

• Long Initial Application: While you can typically receive requested funds from your credit line within a couple of days, the process to get access to a credit line might not be so easy. Lines of credit can have fairly long application processes, including gathering a lot of financial documents and possibly talking to an underwriter. Some online lenders have shorter application processes (some are even automated and only take a few minutes to complete), but they will have higher rates and smaller credit facilities.
• Variable Interest Rates: Lines of credit often have variable interest rates, which means that your interest rate will change along with the prime rate or a similar metric. If the prime rate goes up, your interest rate will also increase, and you will have to pay more for borrowing.
• Potential Revenue Checks Before Borrowing: If you don’t borrow very often, lenders might want to take a look at your finances before letting you draw from your line. This additional check might cause a delay in your funds because you have to gather and send in the documents and await the lender’s decision before you’re allowed to access funds.
• Blanket Liens & Personal Guarantee Required: To be approved for a credit line, you might have to sign a personal guarantee or agree to a blanket lien placed on your business.

For more information on lines of credit, check out our guide to lines of credit.

Business Credit Card Pros & Cons

Business credit cards are credit cards used for business purposes. You can use these cards to pay for goods and services up to your available credit limit.

Credit cards can offer your business savings in the form of rewards programs, and they can make it easier to keep track of purchases and defer payments to a more convenient time. However, if you don’t pay your card off in a timely manner, interest rates can be quite high.

Pros

• Rewards Programs: Credit card issuers reward businesses for using their card. Depending on the card you have, you could earn points for travel or other expenses, or earn cash back, simply by using your credit card. In other words, as long as you pay off your debt in a timely manner, using a credit card can save your business a little money.
• Signup Bonuses: On top of rewards systems, many credit card issuers offer bonuses when you sign up for, including earn points or cash back for putting enough charges on your card within a certain time period, or a 0% APR for a certain amount of time.
• More Time To Pay: Credit cards are the easiest way to defer payments for everyday purchases to a more convenient date. You can use credit cards to smooth out your cash flow and pay at a time more convenient to your business.
• Emergency Funds: As long as you don’t make a habit of maxing out your credit card, you’ll always have a little money at your disposal when you happen to need it.

Cons

• Low Credit Facilities: Credit card issuers don’t typically grant you as large a credit facility as you’d be able to get from a line of credit or business term loan. Additionally, utilizing too much of your credit line can have a negative impact on your credit score, so you will have to consider the consequences of using too much of your available credit line.
• High Rates: Credit cards tend to have higher interest rates than you might be able to get from a loan or line of credit. Typically, credit card rates range from about 10% to 25%, and rates for credit card advances can be even higher. Additionally, credit card rates are variable, which means that your interest rate will fluctuate along with the prime rate.
• Fees: Credit cards can carry fees in addition to the interest rate, such as annual fees, late payment fees, balance transfer fees, foreign transaction fees, advance fees, and others. These fees can add up over time, which could impact the amount you actually save by using the credit card.

Final Thoughts

The financing option that’s best for you will depend on the needs and eligibility of the business. Small business loans are most appropriate for business growth projects and other situations in which you need a relatively large sum of money, whereas lines of credit and credit cards work well for situations in which you need a smaller amount of money quickly for business maintenance or growth. You might even find that your business would benefit from a combination of two or even three of these financing options.

Ready to find a loan, credit line, or credit card for your business? Check out these resources:

• Small Business Loans Reviews
• Business Line of Credit Reviews
• The Best Business Credit Cards