Business line of credit vs. business credit cards

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Dear Business Banter,

What is the difference between business lines of credit and business credit cards? Do I need both? When should I use one over the other? – Amanda

Dear Amanda,

Think of a business line of credit and a business credit card as financial siblings. They share many of the same characteristics, but are two separate products. And they can get along quite nicely.

How does a business line of credit work?

A business line of credit (LOC) is a fixed amount of money a bank allows you to borrow from. LOCs may either be unsecured or secured with assets. They have a draw period, which is the number of years you have to tap into the funds. During that time you can withdraw as much as you like up to the credit line, and only the borrowed amount is subject to finance fees. To access the money you would contact the lender and request it be transferred to your checking or savings account.

The lender will assess the minimum monthly payment due, which may be calculated as a percentage of the outstanding balance or just on the interest. If a debt remains after the draw period ends, the lender will determine the installment payments necessary to repay it based on a term, such as three or five years.

As with all financial products, costs are involved. Depending on the lender, the LOC may come with:

  • Origination fee: Often between 0.5 percent and 1 percent of the credit line
  • Annual maintenance fee: $25 to $50 is common
  • Draw fee: Typically 1 percent of the amount you take out
  • Late fee: Usually $25 to $35
  • Interest: The APR for LOCs varies dramatically. It may be as low as Prime (currently 3.25 percent) plus 1.25 percent (from the Small Business Administration) to APRs approaching 30 percent. There is no interest-free grace period.

The credit line on a small business line of credit can be quite high. Depending on your credit history and the company’s financial health, it can easily be $100,00 or more.

How do business credit cards work?

Business credit cards are like personal credit cards but designed with the small business owner in mind. Most of these cards are unsecured though some are secured. As with business LOCs, they have fixed limits and you can charge up to that amount as needed. Only revolved debt will be assessed financing fees. Unlike LOCs, you can keep the account active for as long as you like.

The credit card issuer will assess the minimum monthly payment due, which is usually 2 percent of the balance (unless the balance is so low that it will be a fixed amount, such as $25). You can use the card for purchases and cash advances.

Regarding fees, there are a few:

  • Annual fee: Some cards have no annual fees while others charge $500 or more
  • Late fee: $28 to $39
  • Cash advance fee: Usually 3 percent to 5 percent of the amount withdrawn
  • Over limit fee: May be $25 to $35
  • Interest: 0 percent to almost 30 percent. On all accounts there is a grace period where interest is not assessed on purchases (there is no grace period for cash advances). For 0 percent APR cards the introductory offer usually lasts between 9 and 15 months before it rises to the regular rate.

The credit lines on business credit cards can be a few thousand, and usually top out at about $50,000.

Line of credit vs. credit card

Now that you know the difference between a line of credit and a credit card, you can determine which may be better for your needs.

Because the limits can be so high, business LOCs are typically used for short to mid-term financing for expensive things you want to pay for over time. For example, you may need $50,000 worth of restaurant equipment. If your credit card has a limit of $25,000 you’d be out of luck, but the LOC would carry you through.

On the other hand, you may just need to spend an extra $1,000 on advertising and can pay the bill in 30 days. With the business credit card you’d get the interest-free grace period. Or, if you used a credit card with the 0 percent introductory rate, you would have even more time to make charges without any fees added to the balance.

There are also rewards to consider. While some business LOCs offer a rewards program, many don’t. Business credit cards almost always do. And if you’ll be flying around the country or world, business travel cards are the way to go because they’re loaded with benefits that can keep those costs lower while offering compelling perks.

Lastly, be aware that, because business LOCs tend to offer high limits, they can be more difficult to qualify for than small business credit cards designed for people with bad credit, which may start out with low limits and allow you to build up to a higher limit with responsible use.

In the end, business lines of credit and business credit cards are compatible products and you don’t have to choose one over the other.