Small-Business Loan vs. Business Credit Card: How to Choose
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Small-business loans and credit cards remain the most popular sources of financing for business owners: 86% of applicants surveyed by the Federal Reserve sought a business loan or line of credit in 2016, while 31% applied for credit card financing, according to the Fed’s 2016 Small Business Credit Survey.
Whether or not you should get a business credit card or a small-business loan to meet your financing needs depends on several factors, including how you plan on using the proceeds, your credit score and the strength of your business finances.
Here’s a comparison of both financing options, including pros and cons and how to choose the best one for your business.
Small-business loans vs. business credit cards at a glance
Small-business loan | Business credit cards | |
|---|---|---|
Loan amount | Up to $5 million | Typically up to $50,000 |
Loan type | Term loan. You get a lump sum of cash upfront and repay it at a fixed interest rate. | Revolving line of credit. Borrow and repay from the credit card as needed, making minimum monthly payments. |
APR range | 6.5% to 99% | 12% to 22% |
Qualifications | Need strong credit and business finances, and collateral may be required. | Need strong credit. |
Best for | Expansion, refinancing debt, working capital. | Working capital, ongoing expenses, emergency cash. |
Small-business loans vs. business credit cards: Which is best for me?
Small-business loans are a good choice if you’re looking to refinance an existing debt, buy real estate or equipment, or make any type of large investment, as these loans provide a larger sum of money. They typically are repaid monthly at a fixed interest rate, making them a good option for financing large investments over a long time period.
These loans, however, are tougher to get approved for than business credit cards, may require collateral and it can take a long time to get funded, depending on the lender. They're best for more established businesses because you’ll likely need strong revenue and business finances to qualify.
Business credit cards are generally better suited to financing ongoing expenses and working capital. A credit line offers flexibility, and you pay interest only on what you borrow, up to your credit limit.
Business credit cards can carry many advantages, such as rewards for spending, 0% introductory annual percentage rates, sign-up bonuses and the ability to build business credit. However, these revolving lines of credit may come with high interest costs and other fees.
Small-business loans: Pros and cons
Pros
Borrowing amounts are higher: Small-business loans guaranteed by the U.S. Small Business Administration have a maximum size of $5 million, while online lenders provide up to $2 million. This makes small-business loans better for a major expansion, such as purchasing or renovating real estate, buying equipment, financing inventory or refinancing debt.
Costs are lower: Traditional banks typically offer the lowest interest rates for businesses with strong finances. For instance, SBA loans — backed by the Small Business Administration but issued by lenders such as banks — are likely to carry lower interest rates than business credit cards. SBA loan rates are set using the current prime rate. An SBA loan of more than $50,000 and paid off in under seven years, for example, carries an interest rate of 6.5%, while a loan of $25,000 or less that’s paid off in over seven years carries a rate of 9%.
Online lenders may also charge lower rates than business credit cards, with APRs starting at 6% for term loans and 8% for lines of credit — typically if you have strong personal credit and business finances.
Long repayment terms are available: Small-business loan repayment terms vary by lender but can stretch as long as 25 years for some SBA loans. This results in much more affordable monthly payments for businesses looking to make a major investment in their business.
Let’s say a business is approved for a $30,000 loan. If the loan has a five-year repayment term at 10% APR, the business owner must make 60 monthly payments of $637.
Check out NerdWallet’s business loan calculator to see the cost and payments for business loans.
Cons
You may need collateral: Some small-business loans require collateral — assets such as equipment, inventory or real estate that the lender can seize if you fail to make payments. Collateral and personal guarantees are required as security on all SBA loans.
Although a default could result in forfeiting the asset, putting up collateral is likely to get you a lower interest rate on the loan than what you’d receive with a business credit card or an unsecured online loan.
Qualifying is harder: Getting approved for a small-business loan likely is tougher than for a business credit card. In September 2017, big banks — those with $10 billion or more in assets — approved 24.8% of small-business loan applications, while alternative lenders approved 57%, according to Biz2Credit.
To qualify for a traditional bank loan, you’ll need good personal or business credit and collateral. For larger loans, you may need a down payment. Traditional banks typically require a lot of documentation, including personal and business financial statements, profit and loss statements, income tax returns and a detailed business plan to prove you can repay the loan.
Many alternative business lenders also require a solid track record of business finances and an average to good personal credit score.
Time to funding is longer: It can take a few weeks or longer to get funding, depending on the lender, while you can get a business credit card within a week after approval.
Bank loans may require you to apply in person and fill out paperwork. You can complete applications at online lenders entirely online and get funded as fast as 24 hours to a few days. However, rates may be higher than at banks.
Business credit cards: Pros and cons
Pros
You might get rewards or cash back: Just like regular credit cards, business credit cards may offer you rewards or cash back on purchases.
However, the rewards may be for business expenses. For example, some cards offer cash back for spending on internet and cable, phone service, gas and office supplies. If a card offers 3% cash back on office supplies and you spend $1,000 per month for your business, that’s $30 back in the form of a statement credit or in your bank account.
Other cards may offer you a sign-up bonus for charging a minimum amount of money on the card in a specific time frame.
They may offer a 0% interest promo: Besides rewards on purchases, some cards may also offer an introductory 0% APR period, during which you’ll pay no interest on your balance.
“Some business owners will get three or four of these cards at 0% interest, with limits up to $5,000 apiece, and immediately have $15,000 to $20,000 of working capital — that’s without going through the rigors of getting a small-business loan,” says Craig Smalley, a small-business lending expert.
If you pay off the balance in full before the 0% period expires, you’ll owe no interest. However, borrowers will still be required to make the minimum monthly payments during this time, and missing a payment could trigger interest charges.
No collateral is required: Unlike some small-business loans, you won't have to pledge assets as security for repayment of the credit card. So if for some reason you stopped making payments, the lender couldn't seize business assets such as real estate, inventory or bank accounts.
It's easier to track business expenses: Using a business credit card can help you track your spending and separate your business and personal expenses, which makes it easier to take proper deductions and do your taxes. The interest you pay on your business credit card may be tax deductible in the year you paid it.
Most credit card companies will provide you with a billing statement each month that has a detailed transaction history. You can also link your card to online financial software such as QuickBooks to keep track of expenses in real time.
You can build business credit: Putting charges on your card and paying them off on time can help your business build its own credit history. A strong business credit score can help you get a larger business loan in the future.
Cons
It's high-cost, variable-rate debt: Business credit cards are unsecured loans, so they tend to carry a much higher APR than secured loans — typically from 12% to 22%, depending mainly on your personal credit score.
The interest rates on most business credit cards are variable, which means the amount of interest you pay on the card balance can rise or fall depending on the prime rate. If rates rise, your payments and interest costs can also go up.
High balance can hurt your credit: Having too high a balance on business credit cards can hurt your credit scores. Both your business and personal credit score take your credit utilization ratio into account, so keep this in mind before racking up too much debt.
Fees can be high: Watch out for high annual fees, late payment fees, cash advance fees and other fees, such as those for being over the limit on the card. For instance, you could be hit with a penalty APR as high as 30% if you miss a payment. Read the terms and conditions on the credit card agreement carefully so you’re aware of all the potential costs.
Personal guarantee may be required: Although business credit cards don't require collateral, you may have to sign a personal guarantee, which makes you personally liable for unpaid debts. If you fail to make payments, the bank could go after your personal assets, and your credit score likely will suffer.
