Countless entrepreneurs have used credit cards to finance their businesses. But be careful how you use them, there are risks involved.
Countless entrepreneurs have used credit cards to finance their businesses because they had nowhere else to turn. Their numbers are growing. According to a recent survey by the National Small Business Association, credit cards had become the top source of small-business financing in the U.S., as other forms of financing have dried up during the credit crunch. But credit card financing has some risks, so it is important to understand the best ways to use your cards before you start borrowing this way.
“I’d only recommend credit cards for the very short term and if you really don’t have any other options,” — Donna Marie Thompson, a former consultant with PriceWaterhouseCoopers
How does credit card financing work?
Once you have opened a credit card account with a bank, you can use your credit cards to pay for business purchases as you go along or to get a cash advance of a specific sum of money you need. The bank that issues a card will give you a credit limit, allowing you to borrow up to a certain amount.
What are the advantages of credit card financing?
Credit cards are quick and easy to use. Once you have the approval to use a card, you can start to put it to work for you.
What are the disadvantages of credit card financing?
It is easy to run up a lot of debt for your business if you aren’t careful. And your interest rates can shoot up quickly if you pay a bill late. “I’d only recommend credit cards for the very short term and if you really don’t have any other options,” says Donna Marie Thompson, a former consultant with PriceWaterhouseCoopers who now advises small businesses as CEO of Goals in Action in Washington, D.C.
Whether you use personal or business credit cards for your company’s borrowing, you will probably have to sign an agreement requiring you to personally guarantee the debt. So, even if your business closes, you may still be on the hook to pay the balances. As a result, it can be personally risky to borrow large amounts of money this way. “I’d try to put up some kind of security other than your house,” advises Thompson.
What is the best way to use credit card financing?
It is a good idea, for tax and accounting purposes, to use business credit cards, rather than personal ones, says Alan Tratner, director of Green2Gold, a nonprofit organization that runs a national network of low-cost work spaces, known as incubators, for environmentally-friendly businesses, and a Santa Barbara–based counselor with SCORE, a nonprofit that provides free and low-cost advice to small-business owners. It can help you build the credit score for your business, improving your access to other types of financing. “It helps you to establish yourself as a business,” he says.
“The more sources of information there are about your company, the easier it is for lenders to confirm that you are an established business.”
How can I maximize the credit available to me?
Before you apply for credit for a business, register it with commercial bureaus such as Dun & Bradstreet, Experian, Equifax, and the Small Business Financial Exchange, advises Richard Flynn, senior vice president and general manager, American Express OPEN, the small-business division of American Express. “The more sources of information there are about your company, the easier it is for lenders to confirm that you are an established business,” he says. Review your company’s profile regularly to make sure there are no mistakes there.
Apply for credit you need before you need it, Flynn says. Finding the borrowing arrangement you need can take time. “If you wait until you actually need it, your credit record may already be less attractive to lenders,” he says. It is a good idea to talk with your accountant or a trusted financial advisor to determine how much credit you should seek, he says. If you seek too little, you may not have enough available to handle short-term cash-flow needs, but if you apply for too much, it can hurt your credit score, he says. “Don’t use it when you don’t really need it,” he says. As a rule of thumb, it is best to reserve short-term credit like credit cards for short-term investments in your business, he says.
How much does credit card financing cost?
Rates are all over the map. Some credit cards have introductory deals in which you pay 0% for a short period of time and then switch to a higher rate. But rates can go as high as 30% or more if you make a late payment or your credit score goes down. The terms of credit card deals got tougher as banks anticipated the effects of a new law, most of which took effect in February 2010, that was aimed to protect consumers from credit-card rate increases.
Are there special considerations for immigrants?
To get a credit card, you will need a strong credit history in the U.S. So, if you’re new to this country, you should take steps to build your credit score by, for instance, opening bank accounts and paying all of your bills on time.