According to a study by the U.S. Small Business Administration Office of Advocacy, only 12% of businesses use a business loan for capital when they are starting out. Business and personal credit cards account for almost twice as much of entrepreneurs’ starting capital. That’s a little surprising because most savvy business owners are aware that carrying balances on credit cards results in interest rates well over 16% these days, according to bankrate.com. Some “fintech” solutions may have effective interest rates that are even higher. The fintech industry includes names like OnDeck and Kabbage.
Credit cards and fintech loans are easy and fast, and entrepreneurs love that combination. For many entrepreneurs, ease and speed are worth the extra expense, until they start adding up the cost.
Here are some options that might work for you.
The SBA offers microloans to borrowers who, for whatever reason, cannot qualify for regular bank financing. When an entrepreneur gets started by running up credit card balances, it may adversely affect the personal credit score of the owner, a double hit because it locks out the entrepreneur from many typical routes of refinancing. Enter the microloan.
“Taking out too many credit cards will reduce personal credit scores and make it even more difficult for a traditional lender to offer a loan,” says Patty Ajdukiewicz, relationship manager for the Economic and Community Development Institute.
The Economic and Community Development Institute (ECDI) provides SBA microloans to qualified individuals who can meet certain basic eligibility requirements and show repayment ability. Microloan rates range from 9% to 12%. That is more expensive than a traditional bank loan, but a fraction of the costs of credit cards and fintech.
Ajdukiewicz notes entrepreneurs should anticipate having to pledge all available collateral when they refinance a credit card loan. While a credit card may leave fixed assets unencumbered, the lender is compensated for that lack of collateral with a high rate. An ECDI Microloan could cut the interest rate in half, but you should anticipate a lien against your business assets, and perhaps personal assets as well.
For slightly larger transactions, Growth Capital Corporation’s Community Advantage program is also available.
“I’ve got one now that we’re approving today. They’re 13 years old and have revenues of $1.3 million. They have over $100,000 in credit card debt. Thirteen years and they have never gotten good advice,” says Kate Kerr, program director. She adds that most of the clients she works with have one or two credit cards, perhaps to take advantage of refund points or free travel. But some companies might end up with dozens of cards, and the debt load quickly becomes unmanageable.
A key difference between responsible term loans and credit card debt is the ease with which the transaction is completed. Credit cards are the easy path, but you pay for the convenience. Expect a much higher degree of due diligence from a lender like Kerr. The rate is much lower, but you must have your financial statements in order.
For example, businesses need to have their tax returns filed so that the loan can be underwritten, Kerr says. Your accountant may have the ability to get you an extension on your taxes, but if you’re in the process of applying for a loan, that is actually not at all helpful. SBA-backed loans such as Community Advantage or microloan typically need financial statements current within 120 days of application.
You can also refinance high-rate loans through most traditional banks. SBA’s loan guarantee programs are available to assist any participating lender, if there is not sufficient capital or time in business to justify a conventional loan.
If you must use fast credit, use the business name
When the outstanding debt is in the name of the business, it is easier for a bank to refinance the higher rate debt. SBA only asks that the bank obtain the applicant’s certification that the debt incurred was exclusively for business purposes. If the balance includes personal expenses as well, these amounts must be excluded.
When the outstanding debt is in the name of the individual owner, it is much more difficult. Lenders must document the specific business purpose of the credit card debt and the applicant must certify that the loan proceeds are being used only to refinance business expenses. Documentation required will include a copy of the credit card statements and individual receipts of any expenses in excess of $250.
If you must start your business on a credit card, at least try to get a card that is in the business name. That will make a future refinance request much easier for the lender to process.
Ray Graves works in lender relations in the SBA’s Cleveland office.