Business LoansBusiness Line of Credit

Business Line of Credit vs Credit Card: Understanding the Difference

business line of credit vs credit card

Money is the lifeblood of a business. You need money to pay employees, vendors or utilities, in addition to other expenses such as rent or equipment leases. Without money, you can’t run a business.

As a business owner, there will come a point at some time or another when you need quick access to money. Having access to flexible on-demand cash is essential to running a successful business. A business line of credit or business credit card offers business owners access to cash to cover short-term capital needs.

Here’s the difference between a business line of credit and a credit card and why they’re both good options for small business owners.

What is a business line of credit?

A business line of credit offers businesses the flexibility to access cash on-demand, up to the credit limit set by the lender.

Similar to a credit card, once you’re approved for a line of credit, you’ll be able to use as little or as much money as you want, up to the credit limit, on an as-needed basis. The interest is only based on what you borrow, not for the total approved amount. Plus, you have the flexibility to pay back the money as quickly as you want or on a monthly basis.

A line of credit is meant to be used for short-term cash-flow needs such as payroll, inventory or basic day-to-day business operating expenses.

Different types of business credit lines

There are three main types of business lines of credit — unsecured, secured and equity line of credit. The main difference is whether or not the lender requires collateral.

Unsecured line of credit. This type of credit does not require collateral; however, the lender will most likely require a personal guarantee. The borrower, usually the business owner, needs an excellent credit score and strong financial history.

Secured line of credit. This type of credit is good for businesses that have non-real estate assets to use as collateral. Collateralized lines of credit typically have better terms, lower rates and higher credit limits than unsecured lines of credit. That’s because lenders look at a secured line of credit as less risky. If the business fails to make payments, the lender can go after the collateral to recoup the balance on the outstanding debt.

Equity line of credit. An equity line of credit is for businesses that have equity in commercial or residential real estate. That equity in the home or business is used as collateral for the equity line of credit.

Is a business line of credit right for you?

When you’re running a business, you have to be prepared for the unexpected. Having a business line of credit to fall back on can give you peace of mind knowing that you have access to cash on demand, just in case you need it.

Many lenders, especially banks and credit unions, can help you get a line of credit.  However, it’s not for every small business and not every business will meet the eligibility requirements. Lenders look at how long you have been in business, how much revenue your business generates each month, business credit history, a guarantor’s credit history and assets.

Many traditional lenders require that you be in business for at least 2 years with minimum annual revenue in the hundreds of thousands.

What is a business credit card?

A credit card is a convenient and secure way to pay for business-related expenses. The four major credit card networks in the U.S. are:

  • Visa
  • Mastercard
  • American Express
  • Discover

Banks or credit unions issue credit cards on behalf of the credit card networks. For example, Bank of America offers three types of business credit cards — one Visa and two Mastercard credit cards.

Companies use special offers to lure in both personal and business credit card customers. They offer statement credits, bonus reward points, and cash bonuses, to name a few.

To apply for a business credit card, you’ll need to give personal information and information about your business including total annual revenue and your business tax ID number. Almost all credit cards require you to sign a personal guarantee for your business credit card. You’re assuming personal liability in case your business fails to pay back the debt.

Similar to a business line of credit, it’s up to the issuing bank or credit union to set the credit limit, rates, terms and fees. Business credit card rates vary by card, your personal credit score and income.

So, why would a business need a credit card?

Just as you use a credit or debit card for purchases, so do businesses. Using a credit card is a convenient and secure way to make a purchase or pay invoices. As an added bonus, most accounting software tools give you the ability to link a business credit card to the software system to automatically track expenses.

You can use a credit card for any business expense, as long as that retailer or vendor accepts the type of credit card you use. As for the credit limit, that’s based on a number of factors. Luckily, if you pay your bills on time, credit card companies are likely to increase your spending limit on at least an annual basis, if not more frequently.

Types of credit cards

There are three categories of credit cards:

  • Personal
  • Business
  • Corporate

Each credit card will have your name on the front. The main difference is who is ultimately liable if the bill is not paid. You’re on the hook for personal and business credit cards.

Large companies or corporates issue corporate credit cards to employees who travel frequently or are responsible for making purchase or expenses on behalf of the company. The company is liable for all charges on the card, you are not.

Is a business credit card right for you?

If you have a personal credit card, were able to open your own business, the likelihood that you will be approved for a business credit card is very high. It’s much easier to be approved for a credit card compared to a business line of credit.

The difference between a business line of credit and credit card

There are many similarities between a line of credit and a credit card. The lender or credit card company sets the maximum amount of money you can borrow at any given time, with the flexibility to use the money as you see fit.

Here’s a breakdown of the pros and cons of an opening a business line of credit or a business credit card.

At a glance: Pros
Line of Credit Credit Card
Access to the money on demand – checks, debit card, money transfer or online Building credit history
Variable interest rates Convenient
Revolving line of credit Reward programs
Higher line of credit Fraud protection

 

At a glance: Cons
Line of Credit Credit Card
High annual revenue minimum Risk of overspending
Personal guarantee High interest rates
Possible misuse of funds Credit damage for late or missed payments
Strict eligibility requirements Not all vendors accept credit cards

The bottom line

A line of credit and a credit card are common short-term financial options for business owners. It is absolutely essential for businesses to have access to cash in order to pay invoices, payroll and day to day expenses, not to mention unforeseen expenses or emergency situations. However, it’s easy to fall into a downward spiral of debt.

If you’ve found yourself in a position where keeping track of your business finances is falling to the wayside, consider hiring a professional. You don’t want to make small missteps that later lead to big failures down the road.

 

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