When you need a little extra to finance your business operations and your current cash flow isn’t enough to do it, it can be tempting to turn to credit cards. They're convenient, they're easier to get than a traditional bank loan, and they can help get you through the months when your small business is short on funds. But are they the best choice? Be sure to keep the following in mind.
Credit cards are expensive.
According to Bankrate’s latest survey of interest rates, the average annual percentage rate (APR) for fixed-rate credit cards was just over 13%, and the APR for variable rate cards was over 15.5%. Compare that with an average rate of just under 8.5% for a small business loan, reported in the latest quarterly survey by the Federal Reserve Board. Depending on how much you charge and how quickly you pay it back, that can add up to a lot of interest.
Credit card terms can be confusing.
After the first twelve months, card issuers can change the conditions on your cards as long as they give you forty-five days’ notice. Changes can include raising the interest rate, which would increase the amount you owe, or changing the annual fee, the charge for cash advances, or late fees.
A card issuer can also cut your credit limit, which can max you out without you even being aware of it. You know that pile of papers you get in the mail periodically from the credit card companies? Next time, you may want to read it before you shred it or throw it away.
If your credit card company is going to make changes to the terms of your card, it must give you the option to cancel the card before certain fee increases take effect. If you take them up on it, the company can close your account and increase your monthly payment, within certain limitations. They can, for example, require you to pay off the balance in a certain number of years, or even double the percentage of your balance they use to calculate the minimum payment you have to make.
Credit card debt can hurt your credit score.
How much credit you use compared to how much you have available to you is known as your utilization rate, and it’s an important factor in your credit score. Historically, utilization is a good indicator of what kind of lending risk you’ll be. Someone who continuously charges all the money they can, hitting or going over their credit card limit, is far more likely to have a tough time repaying that money than someone who uses their cards more sparingly.
Experts suggest keeping your credit-to-debt ratio at below 50%, but less than 30% would actually be ideal. Anything over that, the red flags start to go up, and your credit score can start to go down. There is a little more leeway if you have a low credit limit, but in general, it’s a good idea to keep your utilization rate as low as possible
Your personal credit is also at risk.
Of course you have the best intentions, but if you run into trouble with your business credit card, the potential ramifications don’t stop there. You and your business are inextricably linked, so what you do in one part of your life will affect the other. Keep in mind that you are almost always personally responsible for the debt you assume on your credit cards, even if they have your business name on them. Late payments or defaults on a business credit card will negatively affect your personal credit score, and that, in turn, will affect your future access to business capital.
Understand the benefits and risks of credit card use.
Knowing the potential risks, you may still decide to finance some of your business costs with a credit card, but be sure to read the fine print in the application, along with any changes to your terms that come along after you’ve been approved. It's always better to know more about advantages/disadvantages associated with debt-financing before you jump right into it. Understanding exactly what you’ve signed up for now can save you a lot of trouble and aggravation in the future.