Small Business Loan vs. Business Credit Card: Compare the Pros & Cons

If you're new to the business world, you might assume that a small business loan and a business credit card are interchangeable. However, this couldn't be further from the truth.

Applying for the wrong type of credit could end up being a costly mistake. A small business loan and a business credit card have different features, benefits, and uses. For instance, a small business loan is ideal for making large purchases or investments, while a business credit card is better suited for day-to-day expenses.

Before deciding which type of credit to apply for, it's important to understand the differences between the two and determine which one best fits your business's financial needs.

Differences Between a Small Business Loan vs. Business Credit Card?

The quick answer is that a small business loan is paid back in monthly installments over a fixed period of time.

A business credit card is a revolving credit line that can be paid back over as much time as you need, as long as you make minimum payments.

But that said, don’t do that.

You shouldn’t use a business credit card and carry an ongoing balance.

That gets very expensive, due to the accumulating interest, and it can hurt your credit score.

When Small Business Loans Make Sense

As a rule of thumb:

The best time to apply for a small business loan is when you have to borrow money that you know you won’t be able to easily pay it back in a month or two.

But before you go applying for a small business loan, you want to think carefully about the pros and cons.

There are arguably more pros than cons, but the negatives of a small business loan are pretty serious.

Pro: A small business loan can be easier on your credit.

If you need to borrow a large sum of money, paying it back with a small business loan can be financially easier on your credit than with a small business credit card.

For instance, if your office needed a $10,000 upgrade, you may have the available credit waiting for you, which is great, but if you realize you can’t pay contractors or an office supply store $10,000 in a month, then a small business loan is probably a better option.

But, hey, let’s say you throw caution to the wind and you put $10,000 on your small business credit card – and then you only pay back $1,000 within a month.

What’s the problem, you might wonder...

Especially if the minimum payment is, say, $300. After all, you just paid a lot more than the minimum monthly payment, which is financially smart.

Well, you now have $9,000 left in revolving credit. Interest charges apply to that $9,000, but what may be worse – you’re hurting what’s known as your credit utilization ratio.

The reality is:

Lenders like to see credit card users borrowing no more than 30 percent of their available credit.

So ideally, if you have a $10,000 upgrade, you would borrow no more than $3,000 on a credit card that has a credit card limit of $10,000.

The moment you borrow more than $3,000 on a credit card with a $10,000 available credit limit, and especially if you don’t pay it off within that first month, your credit score will start to take a hit.

If you want another small business credit card or you want to take out a small business loan in the future, you probably won’t get one with the best terms, such as a low interest rate.

Pro: You may manage your cash flow better with a small business loan.

If you simply need to make upgrades or make a purchase to help your business, and you won’t be able to pay back the loan any time soon, a number of fixed payments over a period of time might be just what your accountant ordered.

If you know that for the next four years, you’re paying something like $212 a month for a loan, you can probably manage that a lot more trying to get $10,000 on a credit card paid off as quickly as possible – since you don’t want that revolving credit to bring down your credit score.

Con: Some small business loans have lousy terms.

While business loans can be a good thing, not all business loans are created equal.

If you borrow from an unscrupulous lender, or you take on terms that have a super high interest rate, you could wind up deep in debt and wishing you had never taken out a loan.

So as with anything, you want to do your research and not just take out any business loan and presume that they’re all the same.

When Business Credit Cards Are More Appropriate

Business credit cards can work out beautifully for short-term loans and in general, monthly expenses.

If you want to borrow a little money and especially if you want a rewards business card where you cash back, business credit cards can be a lifesaver.

They can also help business owners manage cash flow.

After all:

Maybe you know you’ve got a certain amount of money coming into the business every month, but you don’t know exactly what day.

Or you simply find it easier to make most of your purchases with a business credit card and then pay off one big bill each month.

Business credit cards also offer extra protections for purchases – extended warranties – that are worth thinking about.

It's when you’re making a purchase that you can’t easily pay off within a month – maybe your business needs to purchase a delivery van – that’s when a business loan can come in more handy.

But you’d never, say, take out a business loan to take a client out to dinner or to purchase an office chair. That’s when you whip out the business credit card.

In a nutshell, some of the pros and cons for business credit cards include…

Pro: Earn big rewards.

If you get a business credit card with rewards, and you pay everything off in full on the card each month, you can often receive anywhere from 1 to 5 percent off certain purchases every month.

Rewards credit cards, in other words, can help a business save money on monthly expenses.

Pro: Manage cash flow better.

Just as small business loans can be tools for managing cash flow, so can credit cards, if you use them responsibly.

If you know that every month, you’re making a big payment to your credit card, rather than a lot of little payments to various vendors, that may be easier on your cash flow.

Con: You could pick one that isn’t a good fit for you.

You want to make sure you choose a small business credit card that works well with how you spend money.

If, for instance, you apply for a travel rewards business card, but you rarely travel (but you’re applying for it because maybe you will travel one of these days), you might end up paying a hefty annual fee – and not getting much rewards for what you’re spending.

Con: There's room for misuse.

As with any small business loan, you could get in trouble with a small business credit card as well. If you don’t make your payments each month.

Credit cards – and loans in general – are incredible business tools, but only if the business is running well.

If your business is struggling to make ends meet, owing money on a credit card could (later) make things worse.

Other Factors to Consider

Of course, in some cases, it may be more practical to get a small business loan, or it may be more practical to apply for a small business card.

You’ll likely want to consider a few factors before you apply for either.

Ease of access

How quickly do you need this money?

In many cases, you can get a business loan with the money in your bank account the same day or at least the next.

With a small business credit card, you may be able to use your credit card number for purchases instantly, after approval (but the physical card may not reach your address for five or seven or more days).

That said:

Check each lender’s terms before you apply.

If you need cash fast, you don’t want to get into a situation where you are approved but won’t be getting the money for a few days.

Limit amounts

You may not be allowed to borrow as much as you were hoping.

That can happen with small business loans and credit cards, but it’s something you’ll want to be aware of.

As you likely know, a lot of this is going to ride on possibly your personal credit score and history and possibly a business credit score (which usually goes from 0 to 100 while personal FICO scores are 300 to 850).

Employee access

This can be a vote toward small business credit cards.

You may not want an employee making many or any decisions involving a business loan or a business line of credit but having a business card to hand out to employees may be a different matter.

Many business credit cards allow employees to be authorized users on the account.

Finding a Small Business Loan vs. a Business Credit Card

Look, it can sound confusing – a small business loan vs. a small business credit card.

They’re really both excellent tools that can help a business grow. But they are tools, and you have to use them correctly – or they can blow up in your face.

But, really, while there is a right and a wrong time to use them, this shouldn’t be a situation where it’s a small business loan vs. a small business credit card.

There are going to be times when your business will need both.

And the genius of both is that if you use either of them responsibly, that’ll help build your credit and increase the odds that you’ll be able to get approval down the road for any business loan or credit line with a low interest rate.