One of the most important decisions small business owners make is when and how to borrow money. With proper financing, a small business can invest in itself and flourish. But mismanagement can strain your cash flow and make it feel like you're working for your creditors rather than yourself.
Small business term loans and small business credit cards are two popular forms of financing. You may already be familiar with these types of financial products as there are similar personal loans and personal credit cards. But re-examine how they work, the differences between a business loan vs. business credit card, and when one may be better than the other, with your business' needs in mind.
What is a small business term loan?
Terms loans have a specific repayment period, or term, that's decided on when you take out the loan. Installment loans, including student loans, auto loans, and mortgages are examples of personal term loans.
For organizations considering a business loan vs. a credit card, a term loan can help with a large funding need. You'll get the entire loan amount upfront, and then pay it off in regular installments (often, monthly payments). Many term loans have a fixed interest rate, so you can plan your monthly budget and cash flow needs ahead of time.
What is a business credit card?
A business credit card is a credit card created specifically for small business owners-there are also corporate cards for large companies. Business credit cards work similar to consumer credit cards, but often offer specific benefits that align with business needs.
You may be able to get free employee cards linked to your account and limit where and how much employees can spend. Business credit cards also often offer rewards on common business purchases, such as at business supply stores or online advertising.
Business loan vs. business credit card: How do they compare?
Business Term LoansBusiness Credit CardsLoan AmountCan range from several thousand to $1M or moreUp to the card's credit limit, which depends on your creditworthinessPaymentsOften, fixed monthly paymentsAt least a minimum payment each monthRepayment PeriodYou may be able to choose from around six months to several yearsNo fixed term, it depends on how much you pay each monthAnnual Percentage Rate (APR)Ranges from around 5% to 35%The average is around 15%RequirementsMay require several years in business, good credit, and established revenueYou may be able to qualify based on your personal credit and business revenueAdditional CostsPotential origination, application, administrative, and prepayment fees.
Late payment fees. Potential annual fees and usage-based fees, such as a foreign transaction fee.
Late payment fees. LiabilityMay be secured or unsecured and you may need to sign a personal guarantee. Generally unsecured, but a personal guarantee is almost always required.
What are the benefits and drawbacks of a business loan?
Pros
- May offer large loan amounts and you receive all the money upfront
- Choose your repayment term, which can influence your monthly payment
- Some lenders don't charge prepayment penalties
- Low interest rates, depending on your business' finances and creditworthiness
Cons
- The minimum loan amount may be more than you need
- There may be an origination fee
- You'll need to apply for a new loan if you want additional funding
- Creditors may ask for collateral and a personal guarantee
What are the benefits and drawbacks of business credit cards?
Pros
- A revolving line of credit that you can use multiple times without reapplying
- Pay no interest if you pay your balance in full every month
- There's no collateral requirement
- May offer rewards, purchase protections, and benefits for small business owners
Cons
- Often has a high, variable interest rate
- Some vendors and suppliers charge fees if you pay with a credit card
- Credit card companies can change your credit limit at any time
- Often requires a personal guarantee
Is it better to get a business loan or credit card?
Understanding how and when to use various small business financing options can help you keep your business running smoothly while increasing your revenue over time. When comparing business term loans vs. business credit cards, each have their place in the mix.
Term loans are best when:
- You need quick access to lots of funding: With a term loan, you receive the entire loan amount as an upfront lump sum. The disbursement method makes them a good choice for business owners who want to finance a large purchase or project, such as renovations, expanding to a new location, covering emergency expenses, buying a competitor, or preparing for a busy season.
- You'll need months or years to repay the loan: You may need several months or years to repay a large loan. Even if you can raise enough money with a business credit card or line of credit, it can take years to pay off the debt and term loans often have lower interest rates.
- You're consolidating higher-rate debt: In looking at the benefits of a business loan vs. credit card, term loans can also be a money-saving tool if you have high-interest credit card balances or higher-rate loans. If you can qualify for a low-rate term loan, you can use the money to consolidate other business debts
- You've calculated your ROI: Term loans can give you quick access to lots of financing, but you'll want to calculate your return on investment (ROI) before taking out a loan. Sometimes, it makes more sense to focus on cutting costs or increasing income sales than to take out a loan and keep a business afloat without addressing the underlying issues first.
Business loan vs. business credit card: Credit cards are best when:
- You need short-term financing: If you're experiencing cash-flow crunches and need helping smoothing out your finances, a business credit card allows you to make purchases today and pay for them later. Timed right, you may have over 50 days between your purchase and the bill's due date.
- You're separating everyday business and personal spending: Some small business owners use the same accounts for both business and personal expenses. But this can lead to headaches come tax time and expose you to additional personal liability. In reference to the question, “is it better to get a business loan or credit card”, opening and using a business credit card solely for business purchases can help you avoid a mess later.
- You qualify for a promotional rate: Some business credit cards offer a temporary 0% APR on purchases during a promotional period. It's one of the few opportunities to borrow money without paying any interest, but make sure you have a plan for paying off the debt. Otherwise, you may be stuck with a balance and high interest rate when the promotional period ends.
- You'll use the cardholder benefits: Business cards may offer a variety of benefits, including rewards, additional warranties on purchases, and free employee cards. But it's only worthwhile if you get a card with perks that align with your business needs, and you remember to use the cardholder benefits.
How do term loans complement credit cards?
As term loans and credit cards can be helpful for different-and sometimes similar-circumstances, you may find yourself using both types of financing while running your business.
For example, you may decide to take out a term loan to expand your business to a new location or start offering a new line of services or products. The loan gives you the initial capital to cover the major costs and invest in the additional employees and materials you'll need. However, it can take time for the new part of the business to pick up, and a business credit card can help with short-term financing.
Both business loans and business credit cards can get reported to the business credit bureaus and help you build business credit, which is separate from your personal credit. In turn, having good business credit can help you qualify for more favorable financing in the future.
What should you look for in a small business lender?
If after comparing a business loan vs. business credit card you find that a small business term loan aligns with your business' needs, you'll still need to figure out where to apply for your loan. Here are a few factors to consider:
- How quickly do you need the money? Banks and Small Business Administration (SBA) lenders may take several weeks or months to go over your application. Online lenders can often give you a decision within a few days.
- Loan amounts and terms: Lenders may have different maximum and minimum loan amounts and repayment terms.
- Interest rate ranges: Often, you won't know the rate you'll be offered until after you apply. However, you can look at lenders' interest rate ranges to get an idea of the best and worst rates available.
- Repayment terms: How frequently do you have to make payments. Weekly or biweekly payments may have a bigger impact on your cash flow than monthly payments.
- Fees: Common fees to look out for include application, prepayment, and origination fees.
As with any type of financing, comparing lenders can help you find the best fit for your business. If you have time, you may even want to submit several applications and compare the offers to see which lender offers the best rates and terms.
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