11 Mar Business Installment Loans vs. Business Credit Cards?
Do you need funding for your business?
There are a ton of options available.
One question customers ask all the time:
“Are small business installment loans better, or should I just use (or apply for) business credit cards?”
Our answer usually depends on the answer to one simple question…
Why Do You Need Money for Your Business?
Did you know…
This one question…
Makes all the difference in the world as to which type of business funding is best for you.
For example:
Imagine your accounts receivable balance averages $50,000.
In a perfect world, all customers pay on time. You could sync payables with receivables. You’d never have to worry about account overdrafts.
That would be great, right?
You probably know… that never happens.
Most businesses need a buffer against cash flow crises.
Aside from slow-paying customers, you could suddenly need cash to:
- buy a large amount of inventory
- promote a new offering
- take an unexpected trip
These kind of expenses are unpredictable and (hopefully) short term.
Credit cards or other types of revolving debt are usually the best way to handle temporary hiccups in your business.
There are other considerations though…
Pros and Cons of using Credit Cards for Business Financing
Credit cards for your business are like medicine.
You should absolutely have business credit available. However, you should use it as sparingly as possible.
The way you use revolving debt in your business impacts your future borrowing ability.
Ideally, use revolving lines to build business credit.
Importantly:
- Using business credit and paying it off frequently shows lenders you can manage debt
- Lenders pay close attention to the percentage of your revolving credit that is “open”
#2, the room available on your credit lines, is called your “utilization ratio.”
Many experts recommend keeping your utilization ratios on credit under 30%.
For example, say you have $40,000 in credit card limits. If you currently owe $20,000 on your credit cards, that is a 50% utilization ratio.
Using 50% or more of your credit lines can hurt your credit score. That makes it difficult to be offered good rates for other borrowing.
Credit cards usually have higher interest rates than some other types of borrowing. The average credit card interest rate is 21%.
Often, you can borrow funds at much lower rates than what credit card companies offer.
When do Small Business Installment Loans Make Sense?
An installment loan, also known as a “business term loan” is repaid over time with a set number of scheduled payments.
When you need funds for long term use, such as an expansion, a term business loan will often be a better idea than most short term business loan options.
One reason you may choose an installment loan over any sort of revolving business credit product is the impact of that borrowing on your credit.
Did you know…
Borrowing above 30% of your available revolving credit balance can hurt your credit score…
… but putting those same balances on installment usually won’t dent your credit at all.
That’s huge…
Further, term loans for your business will usually carry lower interest rates than you would see on a credit card.
The rates (and whether you’ll qualify) for a business installment loan vary based on:
- Your credit (usually both business and personal)
- How long you have been in business
- Your annual revenues
- Profitability
Most business term loans have interest rates from 6 to 18 percent. However, if you or your business have credit challenges or other high risk factors the rates could potentially be higher.
What are the Negatives to Business Term Loans?
Business term loans are usually harder to qualify for than credit cards.
Approval rates are lower, and you will have to jump through more hoops.
Approval for installment loans for a small business will usually require:
- Credit application
- 3-6 months of bank statements
- Profit and Loss statements and balance sheet
- Business debt schedule
- 1-3 years of tax returns
Further, applying and getting approved for a business credit card is often done in minutes. Most business installment loans can take 3-7 days (sometimes more) for approval and funding.
Lastly, many term loans in the marketplace insist on being either “first” or “second” position. That means that if you have other outstanding debt, you may be required to use a portion of the funds to repay existing obligations.
On the plus side, often these sorts of loans can be used to refinance other obligations with lower interest rates and payments.
Conclusion
There is no “one size fits all” when it comes to borrowing for your business. A simple credit card may be the best option for you.
Many times, however, your business will be better served with an installment or term business loan.
It all comes down to your unique situation and needs.