As all small business owners know, there are tons of times where you’ll need cash unexpectedly, whether to cover yourself during a tough season or to go after a growth opportunity. Many business owners like to have a business credit card or line of credit on hand just in case—since both offer revolving credit, you can borrow up to the maximum amount and pay whatever you withdraw back over and over. That’s far more convenient and flexible than dealing with a new loan every time you need working capital.
If you don’t already have a line of credit or a business credit card, you could find yourself in trouble down the line if you need fast capital. But which one is right for you?
Though these two options share plenty of similarities, there are some key differences between them that might make one a better fit than the other, depending on your situation. Let’s dive into the line of credit vs credit card debate.
How A Line of Credit Works
The line of credit has historically been a highly useful tool for businesses with capital needs. Access to an approved line of credit gives companies the flexibility to act quickly when strategic opportunities arise or to address any number of unexpected developments. Suddenly receive an order that your current inventory can’t satisfy? Line of credit. A storm takes you by surprise and forces you to make equipment repairs? Line of credit.
The mechanics of a line of credit are fairly simple—it’s a loan that acts more or less like a credit card, but without many of the typical features offered by cards: cash back, reward programs, grace periods, and so on.
With a line of credit, you’ll get approved for a specific amount of money, then have the option to use those funds as needed, with interest only accruing once money is borrowed. The borrowed money can be paid back immediately or over a predetermined repayment schedule.
Since it lacks many of the popular features attached to credit cards, why opt for a line of credit over a standard business credit card? For one, lines of credit offer more flexibility, including less restrictive cash advance rules. For example, lines of credit typically let you take a cash advance on 100% of the total amount you’re eligible to borrow. Credit cards, on the other hand, are generally far more restrictive, often capping cash advances at about 20%. Credit card cash advances also come with sometimes burdensome fees, usually 1-7% higher than the interest rate on a purchase, while advancing cash on your line of credit is often free of any fees (unless there are withdrawal fees).
Secured vs Unsecured Line of Credit
Lines of credit come in two primary forms: secured and unsecured. Unsecured credit lines are those that are not backed by any asset or collateral. In order to qualify, you’ll instead rely on your credit scores, borrowing histories, debt-to-income ratio, and other factors.
Secured lines of credit are backed by some form of asset or collateral, like property, invoices, or inventory. These are sometimes required for borrowers who aren’t creditworthy enough for an unsecured line of credit. If you default, however, you run the risk of losing any asset used to back the loan, making secured lending a bit riskier for those who aren’t on firm financial footing.
Line of Credit vs Credit Card
Business owners in need of capital might choose to go with a traditional credit card over a line of credit. This comes with a few benefits, like the reward programs attached to credit cards, which can be fairly valuable for business owners. However, there are also a few significant reasons to opt for a line of credit.
Interest rates on credit cards can be substantially higher than those attached to lines of credit, particularly in the event of a missed payment. Many cards also come with associated fees and charges that make them more expensive to maintain than a line of credit. While some banks will assess a maintenance fee on unused lines of credit, many do not.
Another key difference between the two financial products is that credit cards might not be backed by property assets. Also, repayment schedules for lines of credit might be more flexible. While most credit cards have monthly minimum payments, lines of credit often come with less-regimented payment options.
Though businesses have been using lines of credit to support their growth for years, not all business owners are familiar with the product. That’s because credit cards get most of the attention, and many banks don’t advertise their line of credit services nearly as much. The fact that credit card debt in the U.S. had a net increase of $57 billion in 2014 shows just how effective credit card marketing remains.
For many companies, though, the line of credit is the best borrowing choice around. Business owners or individuals looking for maximum flexibility and revolving access to funds should consider using a line of credit to meet their next capital requirements. The caveat, of course, is that lines of credit can be very hard to qualify for. You can always start your search there, and if it doesn’t work out, a credit card remains your next best option.
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from Fundera Ledger https://www.fundera.com/blog/2016/02/24/line-of-credit-vs-credit-card/