As a small business owner looks to borrow money to get set up for success, they’ll likely consider business financing options like loans, lines of credit, and business credit cards. The features of these funding options aren’t always straightforward, and you may have questions about the difference between a line of credit and a credit card. The two operate in similar ways, but they are separate products.
In this article, we’ll look into what lines of credit are, how they differ from credit cards, how to choose between the two, and how to find the right option for your business.
What Is a Line of Credit?
A business line of credit is also called a revolving line of credit that you can borrow from as needed. It’s typically used for short-term financing that can help with the ups and downs of revenue that are common in small businesses..
A line of credit gives you a maximum credit limit and you can borrow up to your limit. You usually only pay interest on what you borrow, and your interest rate can either be variable (it can change with the market) or fixed (it never changes). Your credit limit and interest rate is often based on your creditworthiness and your credit scores, including your personal credit score. With a term loan, on the other hand, you get a lump sum and pay interest on the current loan amount until you pay it off.
Lines of credit have a draw period, or the years when you can borrow money. Typically, you’ll use a business checking account to withdraw the funds. The draw period is followed by a payback period, when you make payments on what you have borrowed. For some lines of credit, you’ll pay a draw fee every time you take out funding. Your payments will depend on how much you borrow during the draw period.
Key Differences: Line of Credit vs. Credit Card
Let’s look at how a line of credit differs from a credit card. The primary difference is that a line of credit lets you borrow money against a revolving credit line (rather than the lump sum you’d get with a loan), while a credit card allows you to make purchases that you then repay.
Both credit cards and lines of credit can be either secured or unsecured, depending on your credit scores and qualifications. Credit cards may offer reward programs that lines of credit do not.
Small business credit cards usually have higher interest rates that are variable, as well as fees for cash advances, while lines of credit offer a fixed interest rate. It’s important to understand the features of each before you decide to use them toward business expenses.
Differences Between a Line of Credit and a Credit Card
Whether your business needs a credit card or a line of credit depends on your specific circumstances. Both can offer an easy digital application process, but they do vary based on credit limits, interest rates, fees, and repayment.
Credit limits
A line of credit will most likely offer a higher credit limit than a small business credit card. Depending on the lender and your creditworthiness, you may be able to access up to $500,000 or more from a line of credit. A high-limit credit card issuer will offer closer to $10,000 as their maximum, depending on the card.
Interest rates and fees
You’ll pay interest on both credit cards and lines of credit, but interest with a credit card is typically higher than a line of credit (although it depends on your application). There’s a wide variation on the interest you might pay. Lines of credit may charge anything between the prime rate + 2.25% and 90% in interest, while credit cards typically charge between 13.5% to almost 30%.
There are also fees associated with the two. Lines of credit may charge a draw fee when you borrow money and an origination fee when you open the line, which can be a flat rate or a percentage. Credit cards and lines of credit both might charge late fees if your payment is past due and an annual fee, depending on the option.
Repayment and usage
Both a line of credit and a credit card have credit limits that define the maximum amount you’re allowed to borrow at one time. A line of credit has a predefined draw period and a payback period. You may have to make interest-only payments during the draw period. This means during the months or years that you’re allowed to borrow from the line of credit, you might have to pay off only the interest you accumulate.
On the other hand, you can use a credit card for purchases at any time that the card is active and you haven’t hit your credit limit. Credit cards require you to make at least the minimum payment from a bank account every month. You can avoid interest on a credit card by paying off your balance in full.
Choosing Between a Credit Card or Line of Credit
Deciding which financial instrument is a better fit for you depends on your needs. If you’re looking for a high credit limit so you can access money as you need it for expenses like expanding your business or hiring new staff, a line of credit might make more sense.
Alternatively, if you just need a way to purchase equipment or office supplies and like the idea of earning rewards on those purchases, a credit card could make more sense.
It also depends on the kind of credit you would be eligible for. If you have solid credit scores, you may be able to get unsecured loans or lines of credit, but if your credit is poor, you may only be able to open a secured credit card until you prove your ability to pay your bills on time and build your credit history.
When to Use a Credit Card
Business credit cards gives you a revolving line of credit that you access with a physical card. There are both secured and unsecured credit cards, depending on what you qualify for. If your credit scores are low, you may be asked to provide collateral (usually in the form of a savings account) to secure the credit card. Over time, if you keep your repayments on or before the due date, you may be able to qualify for an unsecured credit card.
Credit cards are best for expenses that you don’t need cash to pay for. If you are buying used equipment from an individual on Craigslist, it’s less likely that they will accept a credit card over cash. But if you regularly buy office supplies at a store or want to cover expenses that can be paid with a credit card, you can do so.
Rewards cards are an extra perk with credit cards. You can earn points on purchases that you can redeem for travel expenses, cash back, or other items.
Should I use a credit card to pay off a line of credit?
Typically, a credit card will have a variable interest rate that is much higher than what your line of credit would have, however, there are some instances where that is not the case. If you are able to open an unsecured credit card with a 0% APR, it may be smart to pay off a loan or line of credit with it.
Keep in mind that your introductory interest rate will end, and then you may quickly rack up expenses on the remaining balance. That’s why it’s important to pay more than the minimum monthly payments required so that you minimize unnecessary interest expense.
If you need a cash advance to pay off the line of credit, note any fees associated with that, as most credit card companies charge exorbitant fees for cash advances. It may not be worth it to have 0% APR if the cash advance fees end up being more than the interest you would pay on the line of credit.
Does a Credit Card Affect Your Credit Score?
Just like SBA loans, merchant cash advance loans, or most other types of financial vehicles, any credit card debt you take on will impact your credit scores. While having more credit gives you a better debt-to-income ratio, the key is making sure you pay your monthly credit card bill on time and in full when you can.
Late repayment of your credit card bill can not only cause your credit scores to go down (though most lenders will give you a brief grace period before they report the delinquent payment), but also it can cause you to rack up late payment fees.
When to Use a Line of Credit
On the other side, we have lines of credit. You may already be familiar with personal lines of credit like a HELOC (home equity line of credit). A business line of credit (also called revolving credit) works the same way.
Rather than getting a lump sum of cash as you would with bank loans, you are approved for a maximum credit limit that you can borrow against. Let’s say you’re approved for a $1 million credit line. You could take out $50,000 now, $10,000 later, and even $500,000 down the road. You are not obligated to take out all the funds you are approved for.
There are both unsecured and secured lines of credit, depending on your credit scores and other qualifying factors. With a secured line, you may be asked to provide collateral or even cash down against the line of credit.
A line of credit works best when you aren’t sure how much money you need for a project or in working capital over time. You could use it to move into bigger office space, place a larger order for inventory, or hire employees. A line of credit is great for keeping cash flow steady.
Should I use a line of credit to pay off a credit card?
Here’s the opposite question to the one we answered above. If you have a large balance on a credit card (or multiple cards) with a high interest rate, your line of credit could be a smart debt consolidation tool, as long as you have a lower interest rate on it.
It may also be a better alternative to a credit card cash advance since the fees for those are high. If you use your line of credit to lower the interest you pay on debt, make sure to make those payments on time. The easiest way to do that is to set up automated payments from your business checking account, and you may save even more if you pay off the balance before the repayment period is complete.
Does a line of credit affect your credit score?
Just like credit cards, invoice financing, and cash flow loans can impact your credit score, so can your line of credit. Keeping a positive credit history can also affect your credit limit. Making your payments on time will boost your credit scores, and lenders may decide to increase your credit limit if you are a responsible borrower.
Nav’s Final Word: Line of Credit vs. Credit Card
Borrowing money in any form is a great responsibility. The debt you take on can impact your credit with financial institutions, credit unions, and online lenders long-term, so be sure to make on-time payments and monitor your business credit report.
Also, late payments can incur hefty fees. If you absolutely can’t pay on time, reach out to the lender to see if you can extend the grace period for your payment so your credit scores don’t get dinged.
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