Businesses who need a boost in their working capital have a choice between a range of loans and financial products, but of these options, online loans are quickly outpacing credit cards. Why are business owners turning to lines of credit (LOC) over credit cards? The answers vary, but here’s a look at the notable differences between these two products:
- Interest rates
The credit card business model is built on the notion of high interest rates, and, in most cases, card issuers know that their clients don’t take the interest rate into account, so they tend to charge rates that are as high as possible. In contrast, online lenders pair borrowers with underwriters with a unique data-centered process that makes it easy to find the sweet spot: relatively low rates that appeal to both the underwriter and the borrower.
- Approval process
The fact that online lines of credit carry lower interest rates and fees directly ties into the approval process. Credit card issuers base their decisions almost exclusively on the applicant’s credit score and history, while online lenders leverage the power of data to create a more complete picture of their clients.
Online lenders use hundreds of data points focused on aspects such as the applicant’s cash flow, sales numbers, seller ratings on retail sites and even positive comments from customers on social media sites.
- Funding speed
Once approved for a LOC from an online lender, applicants can access the funds almost immediately. In contrast, credit cards often take several weeks to arrive post-approval, although, in some cases, creditors can rush the process and overnight a card to the applicant.
Accessibility to funds is one of the key areas in which small business credit cards surpass lines of credit. Credit cards can be used almost anywhere at any time, and as long as borrowers are under the credit limit, they can use their cards as many times as they want in a single day. LOCs, in contrast, often have limits on how often borrowers can access their funds, and, in some cases, LOCs only allow borrowers to transfer cash into their accounts on a daily basis.
There are pros and cons to both of these options. While greater accessibility leads to more flexibility in spending, it also encourages people to overspend. In contrast, if someone takes daily withdrawals from their LOC, they tend to keep a closer eye on their budget and long-term financial goals.
Credit cards are almost never secured with collateral, and, in most cases, LOCs mirror this trend. However, if a business has trouble securing an LOC based on its sales numbers or other data points, it has the opportunity to explore products backed by collateral. For example, online lenders offer collateral-backed LOCs that are secured by a business’ inventory or equipment. They may also offer factoring loans, which are based on a company’s unpaid invoices (accounts receivables).
- Repayment schedules
While repayment schedules vary slightly when comparing small business credit cards to lines of credit, overall, there are similarities between each product. Generally, credit card issuers charge cardholders only 1 to 2% of the balance, and, in other cases, card issuers require 1% of the balance plus the interest and fees that have accrued during that month. Both of these repayment schedules can lock a business owner into debt for the long term. To illustrate, if a borrower pays a 2% minimum payment on a $5,000 credit card balance, it can take up to 23 years to pay it off. Arguably, credit card issuers embrace this model to ensure a steady trickle of funds from their clients for decades.
In contrast, online lenders aren’t based on this model and instead want borrowers to spend their LOC, repay it and spend it again. To facilitate this, online lenders often require borrowers to pay between one-sixth and one-twelfth of their balances each month. This helps keep borrowers on track and ensures they pay off their LOC within six months to a year.
Lines of credit and small business credit cards share a lot of commonalities. They are both revolving loans, often not backed by collateral, that can provide a working capital boost for small business owners. However, the key differences between these products ultimately affects who should apply for them and whether or not they are advantageous for the business in the long run.