As a small business owner, you wouldn’t want to use a credit card to buy construction equipment, just as a loan wouldn’t be used to pay for a business lunch. Choosing between a small business loan or a business credit card for financing is largely determined by your business needs and credit score.
Business credit cards vs. small business loans
A small business loan is a one-time loan granted by a bank or alternative lender for a particular purpose. Your business receives a lump sum of money that you repay in monthly installments, at a fixed interest rate.
Small business loans are best used to fund long-term growth and capital expenses, such as machinery, vehicles, real estate or building expansion. These term loans are better for larger purchases since you can borrow up to $5 million from a traditional bank. Alternative lenders offer loans ranging from $2,000 to $500,000.
A business credit card provides a revolving line of credit that can be used for any need. As long as you make minimum monthly payments on the balance, you can use a business credit card for purchases up to the limit the card allows. Most credit card limits are $50,000 or less, which is why they are used to support ongoing, short-term financing. Business credit cards are best for everyday expenses, such as supplies, fuel, travel or entertainment, including business meals.
Business loans carry interest rates that are typically fixed for the length of the loan. Credit cards tend to have variable rates and may come with fees. Typical credit card annual interest rates can vary from 12.9% to 29.9%, depending on your credit score. Typical term loan interest rates from a bank range from 5% to 12%.
If your credit is less than excellent or your business is new, you may want to consider an online lender rather than a bank. Loans from online lenders tend to have higher interest rates, from 8% to 108%, and may carry fees or prepayment penalties.
Business credit card: Credit underwriting guidelines for most business credit cards are modest, according to William McSweeney, head of credit and operations for Citizens Bank. Credit lenders look for a federal tax identification, a tenure of at least six months in operation, and a good personal credit score. You may need to provide a personal guarantee; if you do so, you will become personally liable to make payments if the business can’t.
Small business loan: Underwriting for business loans is more extensive, McSweeney says, and a lender will look at business revenue, profitability and the capital structure of the business. Lenders will assess the personal credit history of the business owner and any business credit. You may need to provide collateral or a personal guarantee.
Lenders try to match the collateral to the purpose of the loan, says Gavin Geraci, business lending portfolio manager for PNC Business Banking. “If we’re using a loan to finance a purchase, that purchase is going to be the collateral,” Geraci says. “If it’s a purchase of a building, we’ll take the first mortgage on the building, or if it’s to finance a new printing press, we’ll file a security interest on the printing press.”
If you’re not sure what type of financing is right for you, consult your lender of choice. Geraci says that the way a business manages its cash flow — including payment terms, payroll, marketing and one-time expenses — can help determine which financial product is best.
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