Managing business expenses requires planning and a solid backup for times when there is not enough in the account. A business line of credit (LOC) and a credit card both exist for this purpose: they help you keep the ball rolling when sales are low or a sudden expense shows up.
However, given the similarities between these two options, business owners must have clarity about which one is meant for this situation. This article will try to settle the line of credit vs credit card debate, so you can choose the right one.
Keep reading to ensure you always have backup business financing without being tied down by the specifics.
Line of Credit vs Credit Card: Key Aspects
Before discussing which business financing will better suit your business, let’s establish the key difference between LOCs and credit cards:
Line of Credit
A business line of credit is flexible funding you can access when required. If your business qualifies, the lender approves you for a credit limit, you draw the required amount, and interest applies only on what you take out, not the entire amount. For instance, if you’re approved for $40k but only draw $15k to cover payroll during slow months, you repay it when the finances improve, and only the $15k you used accrues interest.
Credit Card
A business credit card is similar to a line of credit, only you use it for purchases and not cash withdrawals. For example, you can swipe a credit card while traveling for work or to purchase office supplies. Much like your personal card, the one used for business purposes gives you a limit, you spend against it, and pay it off monthly to avoid interest. When you use the available limit, you must repay a minimum monthly amount, regardless of whether it’s a slow season and your business isn’t doing well.
Let’s now dissect these financing models’ specifics to understand how they differ:
Cost of Debt
Calculating the cost of debt isn’t straightforward for most financial products because it varies and piles up depending on what you do.
But put simply, a line of credit comes with an annual fee and, sometimes, a draw fee when you use the available cash. You don’t pay interest on the approved credit limit, and the amount used also comes with relatively lower interest. However, you start accruing interest on a line of credit immediately, which piles up, and by the time you repay the borrowed amount, a significant interest will be added on top of it.
On the other hand, a credit card usually skips the annual fee, but its interest rates can be considerably higher than a line of credit. Also, if you carry one month’s due payment to the next, further interest is added, which can easily dent your operational cash flow. Yet, these cards also let you borrow money without incurring interest if you repay the balance in full.
Keeping all this in mind, while one of these options might look cheaper on paper, the exact borrowing cost for both these financing solutions depends on the lender and how you use them.
Credit Limit
Credit limit is the maximum amount a lender allows you to borrow at any given time, so it’s a major distinguishing factor between a line of credit and a credit card. You’re encouraged to opt for a line of credit for bigger business tasks, i.e., equipment purchases, inventory restocks, etc., because it gives you a higher credit limit. In numbers, business lines of credit often have limits that exceed $250,000 and can support crucial operations.
Conversely, a credit card will offer a smaller limit and be suitable for everyday purchases and operations. Although the lender will decide the exact limit you get approved for, it mostly stays under $50,000 for small businesses, and naturally doesn’t serve as your emergency cash injection.
If you require financing help for small operations and are doing well revenue-wise, a credit card is a good fallback option. But if a planned business expense is approaching and there are no funds in the bank, a line of credit will work.
Repayment Terms
As explained earlier, a line of credit has a draw period (mostly between 1 and 5 years), during which you can borrow funds, repay, and borrow again. You pay the accrued interest during this time, and when it concludes, you’re required to clear the full borrowed amount.
A credit card, however, doesn’t have a draw period, and the balance you use immediately starts accruing interest. You also pay a minimum monthly amount to keep the credit account and maintain your credit score. There is no scheduled repayment phase or end date, unless you wish to close the account.
In short, a line of credit offers a set borrowing and repayment cycle, while a credit card requires ongoing monthly repayment to avoid interest.
Best Use Cases of Line of Credit vs Credit Card
Neither of these financing models inherently has the upper hand; it’s their use that makes them suitable or impractical for a given situation. That said, here are some standard uses of both these lending solutions:
Line of Credit
- Payroll
- Inventory purchases
- Equipment repairs
- Cash flow gaps
- Seasonal expenses
Credit Card
- Software subscriptions
- Travel expenses
- Office supplies
- Vendor payments
- Client entertainment
Conclusion
Business financing is crucial for success, and when it’s designed to support your exclusive goals, you use it even more confidently. Summing up the line of credit vs. credit debate, financial experts agree that credit cards are a better option for regular expenses because swiping them brings rewards and points. But when dealing with a larger business expense, a line of credit offers practical coverage. If you need more information about any financing solution, ROK Financial is a call away. Our team of pros will guide you towards the best option, and our value-loaded blog section will educate you on all types of financing—do visit it.
FAQs
Can I get a business line of credit or credit card with bad credit?
Yes, but there won’t be many options. A line of credit becomes harder to qualify for since lenders prioritize positive credit history heavily, especially when there is no collateral. In that case, a secured card or a line backed by assets is the more realistic path.
Can I switch from a credit card to a line of credit later?
Yes, many businesses start with a credit card and move to a line of credit after establishing revenue and credit history. But there’s no formal switching process; you apply for a line separately and can use both together if needed.
Do I need a personal guarantee for these loans?
Yes, you might need it, especially if you’re a newer or smaller business. Lenders ask for a personal guarantee to reduce their risk when business credit history is thin.