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3 types of credit and how to use each
Learn about the three main types of business credit and when you should use each.
Presented by Chase for Business.
Whether you’re starting out, scaling operations or recovering from a setback, credit is an important tool for businesses.
Smart credit use can lead to more borrowing power down the road. It can help with cash flow. It can give you the power to strategize for the future. It can pave the way for growth.
There are three main types of credit, and each can increase a business’s financial power in a different way. Learning the advantages and limitations of each will help you feel confident that you’re choosing the right financing option for you and your business. Keep in mind that these credit options are compatible and that it may be advantageous to use more than one type at the same time.
Business credit cards
Because they function the same way as personal credit cards, business credit cards can be a familiar form of credit for business owners.
A type of short-term loan, credit cards are issued by a financial institution and allow the card owner to increase their purchasing power up to a set credit limit. Each credit card comes with its own terms, including how much interest you’ll accrue by carrying a balance from one billing cycle to the next.
Where business credit cards differ from personal credit cards is that they tend to have higher credit limits, different bonus categories for earning rewards and shorter 0% APR introductory periods. In addition to reporting to commercial credit bureaus, some credit card companies report business credit card activity to consumer bureaus, which will affect your personal credit.
Another advantage of business credit cards is convenience. They essentially give you working capital in your wallet as most businesses accept credit cards as payment. The approval process involves a credit check, but credit cards are an option for businesses that don’t have a well-established credit history and might not qualify for other types of credit.
Business credit cards can pair with accounting software, making it easy to track everyday business purchases. Plus, they let you extend purchasing power to other employees, though this should be accompanied by a thoughtful policy that is clearly communicated and ensures accountability.
Business lines of credit
A business line of credit is what some might consider the next step up from a business credit card — a short- to mid-term loan that provides a business with access to money that can be used for business expenses.
Similar to a credit card, a business line of credit designates an amount of money a business can borrow. Interest accumulates once you withdraw funds, and you can borrow more once you’ve paid down your balance.
Business lines of credit can be secured, meaning you’ll need to put up assets as collateral to qualify. Or they can be unsecured, meaning no collateral is required.
They’re typically used for many of the same things credit cards are used for, including managing cash flow, buying inventory or covering payroll. Where business lines of credit differ from credit cards is that they often have higher limits and lower interest rates. It makes them an option for funding large purchases that might exceed a credit card limit or with merchants that don’t accept credit card payments.
The qualification process for business lines of credit can be more rigorous and may take several weeks. Some financial institutions may require that the business be under current ownership for a set amount of time.
For business decisions that require more capital, a longer-term financing option is a business loan.
A loan is an upfront lump sum that can come from commercial banks, credit unions, public funds or private investors. In exchange, the business agrees to pay back the money in accordance with the loan’s terms, which include a fixed interest rate, fees and designated repayment periods (five years is typical).
Unlike credit cards and business lines of credit, loans typically require you to tell the lender what you’ll use the funds for. Your business may need to meet qualifying requirements, such as years in business and minimum annual revenue. To determine your capacity to repay the loan, you must also undergo an approval process that reviews your credit history, debt-to-income ratio and availability of business capital — all factors that can affect the loan amount and terms.
Keep in mind that business loans frequently require collateral, which for businesses can be inventory or accounts receivable. Some loans require a personal guarantee that requires the borrower to repay the debt with personal funds if they default.
Loans are an option for financing a business launch, funding an expansion, purchasing equipment, refinancing debt or acquiring real estate. If you’re looking to start a business and seeking a loan to cover the startup costs, you’ll likely need to present the loan officer with a business plan that details your product or service, a market analysis, your sales and marketing strategy and financial projections.
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For informational/educational purposes only: The views expressed in this article may differ from those of other employees and departments of JPMorgan Chase & Co. Views and strategies described may not be appropriate for everyone and are not intended as specific advice/recommendation for any individual. Information has been obtained from sources believed to be reliable, but JPMorgan Chase & Co. or its affiliates and/or subsidiaries do not warrant its completeness or accuracy. You should carefully consider your needs and objectives before making any decisions and consult the appropriate professional(s). Outlooks and past performance are not guarantees of future results.
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