Should You Pay For Business Expenses With A Line Of Credit Or A Credit Card?
Is your business hard up on cash? In need of a rainy day fund? Wanting to save a bit with every purchase? If you’re asking any of these questions, you might be speculating whether a credit card or line of credit could make a great addition to your business.
Credit cards and lines of credit share many characteristics. Business owners may wonder how they differ at all, and whether it’s better to make your business purchases with one or the other.
In fact, there are a few key differences that can help businesses determine when to use one or the other to make your purchases. Those differences aren’t exactly easy to understand right off the bat. As such, we’ve written this article to help you dig into the differences between a line of credit and a credit card.
Curious to know which is right for your business? Keep reading find out if a line of credit or credit card is best for you!
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Line Of Credit VS Credit Card: A Quick Comparison
Credit cards are technically revolving lines of credit, though they aren’t often called that. As you pay off your balance, that credit becomes available to use again. Compared to business loans, lines of credit and credit cards are both convenient for small and recurring purchases. In some cases, you may even be able to use your line of credit at the point of sale (like a credit or debit card) — this is more convenient and safe than carrying around a wad of cash.
Beyond those similarities, both credit cards and lines of credit accrue interest on any outstanding debt, not unlike business loans. You’ll also have an easier time qualifying for the best line of credit or credit card if you have a strong credit score. Both credit cards and lines of credit also come in secured (requiring collateral) and unsecured forms, though you’d only want to go the secured route if poor credit keeps you from qualifying for something more traditional.
The differences between revolving lines of credit and credit cards are a bit more subtle. For starters, a line of credit often comes with more fees than does a credit card. You may, for example, have to pay a monthly or annual fee to keep your line of credit open. While some credit cards (particularly business credit cards) do come with annual fees, it’s not hard to find ones that don’t. Some lines of credit will also charge a fee every time you make a withdrawal.
Though it will vary from case to case, you can also generally get a higher credit limit through a line of credit than with a credit card. That said, some business-specific credit cards are known for allotting higher credit limits than their consumer counterparts — potentially making this point moot depending on your business situation.
You will usually need to make monthly payments on your outstanding balance for both financial products. However, some alternative lenders offering lines of credit may expect weekly or daily payments deducted from your business savings or checking account. It is very rare for credit card issuers to require payments much shorter than a month apart.
Note that it’s a lot easier to get a credit card than a line of credit, although getting an elite credit card can be challenging in its own right if your credit history isn’t great.
When & How To Use A Line Of Credit
Lines of credit are convenient whenever you need to produce a good chunk of cash on short notice. You won’t incur premium fees for withdrawing that money and you won’t be limited to only a fraction of your credit limit. This can be especially useful if you need working capital to cover a broad range of business expenses beyond simple retail purchases and monthly bills.
A line of credit’s lower interest rates may also make it preferable when we’re talking about big-ticket items you can’t pay off quickly. If you’re using your credit card optimally, you shouldn’t be paying any interest on it at all because you’ll be paying it off in full each month. If you can’t do that, a line of credit may often be cheaper over the long run while having more structured payments than you’d get with a credit card.
How Lines Of Credit Work
Lines of credit operate somewhat like virtual credit cards. With a line of a credit, a lender will grant borrowers a credit limit. This credit limit equals the maximum amount of money a borrower can access on the account at any one time. Instead of swiping your card, however, you’ll draw your funds from your line of credit directly into your bank account.
If you have a revolving line of credit, you can keep dipping into your account like a credit card. So should you borrow a sum of money and pay it back, you’ll be able to access the same amount of credit you originally had available.
Note that not all lines of credit are revolving credit. When a bank extends you a line of credit, it may be a one-time offer. Usually, when a financial institution extends non-revolving credit it’s to cover a specific expense the borrower is seeking to fund. Unlike a loan, a line of credit gives the borrower some extra flexibility to negotiate with price with vendors.
Lines of credit can also vary on their duration, grace periods, interest, draw fees, and security. Many that last longer than a year can also be subject to an annual review. And if you do keep a line of credit open longer than a year, there may be an annual fee to boot.
Unsecured Lines Of Credit
Getting an unsecured line of credit means you won’t have to put any assets up as collateral. Generally speaking, these are more difficult to qualify for over a secured line of credit because the lender needs to know that you are trustworthy. As such, you’ll generally need to have a solid and built-up credit history.
Additionally, unsecured lines of credit often see higher interest rates than secured lines because there is more risk on the lender’s side. Most credit cards are technically an unsecured line of credit.
Secured Lines Of Credit
Secured lines of credit (you may also see these called “asset-backed lines of credit”) are backed by specific collateral. In most cases, this is a business asset that can be seized should you default on the agreement you made with the lender. Some lenders may also accept personal assets as collateral. Here are some of the more common forms of collateral that can be used for a secured line of credit:
- Accounts receivable
- Commercial real estate/land
The exact requirements for collateral will depend based on the lender’s policies, your personal credit history, and the account’s credit limit.
Why Use A Line Of Credit?
One thing credit cards are really inefficient at is cash advances. Most credit cards will only allow cash advances up to a fraction of your credit limit. Even then you’ll usually incur very high-interest fees accessing that cash that are far higher than you’d get from most lenders.
Lines of credit, on the other hand, are convenient whenever you need to produce a good chunk of cash on short notice. You won’t incur premium fees for withdrawing money and you won’t be limited to only a fraction of your credit limit. This can be especially useful if you need working capital to cover a broad range of business expenses beyond simple retail purchases and monthly bills.
Lines of credit might also be better if you are making a big purchase and need to carry a balance. While lines of credit do often impose extra fees not seen with credit cards, their interest rates are generally lower. This could make a line of credit a great backup option in case your business gets hit with a large unexpected expense.
When & How To Use A Credit Card
Credit cards are designed to make retail purchases easy. Most merchants these days are equipped to swipe your card (or read your chip) at the point of sale. With some rare exceptions, it’s not easy to apply for a term loan at the time of purchase. Even business owners with a line of credit in place may not have a way to directly use that money at the point of sale without first moving it to another account.
Credit cards are also more ubiquitous in this card-driven online market. Chances are you’ve regularly used your credit card on Amazon or to make utility payments. It’s just as easy to use your credit card for common expenses. In fact, credit card companies try to encourage you to do so through reward programs. The terms of these programs vary, but essentially they all return a small percentage of the money you spend on purchases to you in the form of statement credits, cash, gift certificates, or other products.
How Credit Cards Work
Credit cards are pretty straightforward. Once you apply for a card and are approved, the issuer will designate your credit limit. This limit is the amount you can charge to the card before it needs to be paid off.
With the card in hand, you’ll be able to charge most purchases to the card. In many situations, these purchases will earn you rewards (these rewards are usually worth less than 5% of the purchase amount). When you charge a purchase to your card, the amount will be added to your card’s account balance.
You’ll need to pay off your card’s balance every month. If you fail to do so, you can be charged interest — this is where having a credit card can become pricey.
What You Need To Know About Carrying A Balance
If you’ve put a lot of purchases (or a large purchase) on your credit card, you may not be able to pay off your monthly balance. In this scenario, you’ll be charged interest on the amount you don’t pay off. Besides the interest potentially costing you a lot of extra money, carrying a balance can harm your credit score. A lower credit score can be very detrimental to a small business owner — it can impact your ability to request loans, qualify for credit cards with better rewards, and much more.
Note that some cards can help you avoid paying interest by offering a 0% introductory rate. If you sign up for 0% introductory APR card, you won’t be charged interest on purchases while the 0% rate period is active. Many business credit cards offer intro rate periods that last for the first six, nine, or 12 months after you sign up for the card.
Cash Back VS Points VS Travel Rewards
Credit card rewards primarily come in three forms. We’ll look first at cash back, which sees you earning a small percentage (usually between 1% and 5% — the exact amount depends on the card) of your payment back on purchases. In most cases, your card issuer will deliver your cash back as statement credits, a check, or directly into your bank account. Cash back is usually the simplest and easy rewards scheme to deal with.
Another common reward scheme will see your snagging points for your purchases. If your credit card earns points for rewards, you’ll often collect between 1 and 5 points for every dollar you spend with the card. These points will be deposited in a rewards account that can often be accessed via your card issuer’s website. You can then redeem your points for a variety of options, from travel bookings to gift cards to cash. 1 point usually equals one cent in cash value.
The third common reward scheme gives you travel rewards for your purchases. This method acts similar to points; you’ll receive rewards — often called “miles” — based on how much you spend (usually between 1 and 5 miles per dollar spent). These miles can then be redeemed for travel purchases through your card issuer’s website. In some cases, issuers may allow you to transfer your miles to airline or hotel loyalty programs.
Secured Credit Cards
Secured credit cards can be a viable option for those with poor credit histories. If you apply for a secured credit card, you’ll be asked to first put down a security deposit as collateral. The amount you deposit will generally be equal to your credit limit for the card.
This type of credit card may suffer when it comes to rewards or benefits. Additionally, your available credit may be limited by the amount you can deposit. However, once you use a secured credit card responsibly, you should eventually be able to graduate to an unsecured card. These unsecured cards will lack a deposit and often feature better rewards and benefits than their secured card brethren.
Because of the downsides, secured credit cards should only be on your radar if your credit history isn’t strong enough to qualify for an unsecured card.
Why Use A Credit Card?
There are plenty of reasons for using a credit card. Because they are so ubiquitous in today’s society, you’ll be able to use credit cards when paying at most merchants. Many cards also come with solid rewards schemes, nifty extra benefits, and other perks, such as 0% interest periods or welcome offers. A credit card can be a great tool to add to your business’s financial arsenal — as long as you can pay off your balance regularly enough to avoid interest.
Credit cards are also generally more flexible and cheaper than signing up for a line of credit. You won’t have to worry about dealing with annual reviews or paying fees just to access your credit. The fact that credit cards also offer rewards is the cherry on top.
Which Is Better For Your Business?
For most businesses, credit cards will do fine. These bits of plastic will enable you to charge purchases to your card without needing to carry cash on hand. Plus, you can take advantage of any rewards or benefits included with your credit card.
However, in some situations, a line of credit does make sense. For instance, if you need a higher credit limit, a line of credit could serve your business well. Or perhaps you know you’ll be making a purchase that you can’t pay off right away — a credit card’s high interest rates might make a line of credit more appealing. You may also want to withdraw cash directly into your bank account and a line of credit works better at that than a credit card.
If you’ve decided a credit card is right for you, peruse our best business credit cards article. Or, if a line of credit would suit your business better, we’ve got you covered there.
Whichever option you chose, make sure you use it responsibly. By not going delinquent on your account or spending frivolously, you’ll limit any potential harm to your credit score. Hurting your credit score can impact your business negatively in the future — it’s just not worth the risk.
Responsible use of a credit card or a line of credit should ultimately help your business, too. By giving you access to extra cash flow, you’ll be able to reinvest in purchases that you might not be able to make otherwise. Plus, responsible use now can strengthen your credit score — giving lenders more reason to trust you in the future.