Line of Credit vs Credit Card
As a small business, there are several instruments of credit you can use to finance purchases, both big and small. Two of the most useful are a business line of credit loan and a business credit card.
Though similar in a few ways, these two financing instruments aren’t exactly identical, and it’s important to know the difference between a line of credit vs. credit card so you can pick the right type of credit for your company’s needs.
What is a Line of Credit?
Line of credit loans are types of financing tools in which a borrower can “draw” against a pre-approved credit limit to access capital. These are what’s known as “revolving” loans, since they replenish once you pay back the capital you’ve drawn.
There are a few types of line of credit loans available, including business lines of credit, personal lines of credit and home equity lines of credit. A personal line of credit and home equity line of credit are options for small businesses, but should be seen as contingency plans versus a business line of credit.
For small businesses that don’t have excellent credit, there are also some options for lines of credit for bad credit. Lines of credit are not used as debt consolidation loans.
What is a Credit Card?
A credit card is a tool to finance purchases, generally in the short-term. There are credit card options for both business and personal use. Credit cards are also revolving tools, which means your full credit line will be available once you repay your outstanding balance.
Like lines of credit, credit cards are issued by financial institutions, and credit lines and interest rates are contingent on a borrower’s creditworthiness. Most credit cards are unsecured, which means you don’t need to provide a payment to the issuing institution to receive the card. For borrowers with bad credit, a secured credit card is generally a more likely option.
Some borrowers can use business credit cards for debt consolidation purposes.
Line of Credit vs. Credit Card: Key Differences
There are some similarities for lines of credit vs. credit cards, such as the fact that they are revolving financing tools issued by financial institutions. Both are excellent for purchases in the short-term, or to take care of emergency expenses.
However, there are differences between lines of credit vs. credit cards, too.
| Line of Credit Loan | Credit Card | |
| Average APR | Business lines of credit carry interest rates between 7% and 25% generally. APR rates on lines of credit loans vary based on a borrower’s creditworthiness; the better your credit history, the lower the interest rate. | Business credit cards carry interest rates between 2% up to 30% generally. APR rates on credit loans vary based on a borrower’s creditworthiness; the better your credit history, the lower the interest rate. |
| Credit limit | Credit limits on lines of credit are generally higher than for business credit cards. | Credit limits on business credit cards are generally lower than for lines of credit loans. |
| Secured vs. unsecured | Both secured and unsecured lines of credit are options for borrowers. Lines of credit for bad credit generally require collateral, and are thus secured. | Most credit cards are unsecured. Candidates with bad credit who can’t qualify for an unsecured credit card have the option to apply for a secured credit card. |
| Credit score requirement | Borrowers generally need to have at least a credit score of 500 to qualify for a line of credit loan. | Borrowers generally need to have credit scores of 640 or higher to qualify for a business credit card. Some borrowers with lower credit scores, down to 550, can qualify for secured credit cards. |
| Fees | There are often fees to open up a business line of credit. Some lines of credit require an annual maintenance fee, and some require a fee for each draw. | Only some business credit cards require fees to open and maintain a card, generally paid annually if required. |
| Draw period | Lines of credit generally have a “draw period” in which you can access funds. Borrowers have to pay back outstanding balances before being able to access capital again during a draw period. | Cardholders can spend money at any point on a business credit card up to their credit limit. |
| Grace period | Often, business lines of credit don’t offer a grace period. Some lenders that do offer a grace period only give a short window, such as 10 days. | Financial institutions are more likely to give a grace period of a credit card. Grace periods can be as long as 21 days in some instances. |
| Access to funds | Borrowers can get funds quickly through lines of credit, but in some instances, the draw may take one to two business days to hit their bank account. (This, however, is much faster than accessing capital through term loans.) | Credit cards enable instant access to funds, meaning the cardholder can spend the money they need immediately at any vendor that accepts credit card payments. |
| Application process | Application processes for lines of credit are generally more intensive. Lenders require credit scores, as well as documentation that proves your revenue. (It’s worth noting that the application process for lines of credit loans are much shorter than term loans.) | Application processes are generally simpler for credit cards. Financial institutions often only request a credit score (either personal, business, or both). |
| Common uses | Lines of credit loans can be used for both short-term purchases and medium-term investments. They can also be used for larger investments you plan to pay off over time. | Business credit cards are generally used for short-term purchases as well as everyday spending. |
When to use a Line of Credit
A line of credit provides flexible capital for many different types of expenses. They are a good fit to take care of short-term expenses and emergencies like repairs; some small business owners choose to use capital from lines of credit to make investments, such as purchasing inventory.
Lines of credit are also very useful to supplement cash flow, when you need to cover expenses such as payroll, supplies, or overhead.
Additionally, lines of credit can be used to make larger purchases that you plan to pay off over time. This can come in handy when your business needs to do something like replace a vital piece of machinery, for instance, and you need to be able to draw a large sum of money to be able to make the purchase. You may want to use a line of credit for purchases that may end up costing you more than you expect, since your credit limit is likely higher than a credit card, and interest rates are lower if you need to pay off the purchase over time.
When to use a Credit Card
A credit card is a good financing tool for short-term purchases and everyday spending. A credit card isn’t a good option for long-term investments, or expensive repairs, as interest rates on credit cards can be high, and not repaying your bill in full and on time can be detrimental to your credit score.
You should use a credit card for standard, daily purchases that you plan to be able to pay back in your billing cycle. In some instances, credit cards provide rewards to cardholders, such as cash back or points you can redeem for things like travel down the line, which can be beneficial to business owners. (Lines of credit, in contrast, do not.) This doesn’t mean you should make large purchases on a credit card just to rack up rewards, but this can be a perk of using a credit card for those small business expenditures.
Credit cards are good tools for businesses to have as they need to be able to make purchases, but are not as powerful financing tools as line of credit loans.
Alternatives to lines of credit and credit cards
There are alternatives to lines of credit and credit cards for business. For instance, you can look into other loan types:
- Equipment financing: You can seek out an equipment loan if you are looking to finance a specific asset instead of needing general use capital.
- Term loans: You can pursue term loans and short-term loans, which are lump sum payments, in contrast to revolving credit.
- SBA loans: You can look into SBA loans, facilitated by private lenders and guaranteed by the US Small Business administration. These are often harder to qualify for than lines of credit loans and credit cards.
- Personal loans: You can use personal loans, personal lines of credit, and home equity lines of credit and loans if you don’t want to go (or can’t) through your business.
If you want to eschew a credit product entirely, you can look into alternative ways to access capital and have money on hand:
- Investors: You can seek out private capital or investors if you want to sidestep borrowing money altogether. Investors generally require equity in your company in exchange for capital.
- Savings: If it’s possible with your current cash flow situation, you can make a goal to set aside funds to build up your savings. This way, you won’t have to borrow in order to access capital as you need it.
- Grants: There are many small business grants for entrepreneurs that don’t have to be paid back. You can look to resources in your community as well as identity-based grants, such as for women business owners or minority business owners.
- Renting: If you don’t need to directly own an asset, such as a piece of machinery or real estate, you can look into renting instead of outright purchasing.
Conclusion
Both business lines of credit and business credit cards can be good options for small businesses. However, many small businesses find it helpful to have a business line of credit open. Because you only have to pay interest on a business line of credit if you draw from the line of credit, you can keep a business line of credit waiting in the wings, so to speak.
It’s also possible to simultaneously keep a business credit card, which may be a good option for smaller purchases. Businesses should evaluate their needs for capital in order to decide which option is best — or if both can be helpful in tandem.
