Some Businesses Turning to Credit Cards In Place of Loans

What can only be described as one form of desperation, a recent survey by the National Small Business Association revealed that many small businesses are turning to high interest credit cards in place of hard-to-get commercial loans. Money is certainly scarce, but one has to wonder exactly what kind of fallout this is going to cause down the road.

The 30% interest rate on their small business credit card shocked James and Heather Hills enough to stop using it entirely in April. The couple had turned to credit cards in early 2006 to get their Elgin (Ill.) startup, mhn Internet Marketing and PR, off the ground, after three loan officers told them that they wouldn't qualify for a bank loan without capital equipment to put up as collateral. So the Hills, who have no outside employees, took out a $50,000 home equity line of credit and two personally guaranteed small business credit cards.

They had a handle on their debt until a partner abandoned a planned joint venture in March 2007 and the Hills were left with almost $10,000 for the project on their Advanta (ADVNA) card. Since then, they say they've been late on a couple of payments, and their interest rate has steadily increased from 11.74% to 30.99%. "It suddenly starts being several hundred dollars worth of interest charges," James Hills says. Even without new purchases, they don't expect to pay off the remaining debt, still over $6,000, before 2009. (Advanta, citing privacy laws, declined to comment.)

While data on small business borrowing is scattered, indications show that entrepreneurs are increasingly relying on credit cards to finance their businesses, especially early-stage companies. The percentage of firms using credit cards has jumped from 16% in 1993 to 44% today, according to surveys by the National Small Business Association, a trade group. In the same period, the proportion using bank loans dropped from 45% to 28%. A Federal Reserve survey showed that the percentage of firms using business credit cards jumped from 34% in 1998 to 48% in 2003. And numbers from the NSBA and the Fed show that between 20% and 30% of all small businesses carry a revolving credit-card balance, rather than paying their bills in full each month.

"We don't have an alternative right now," says NSBA chair Marilyn Landis, a former bank executive who now runs Basic Business Concepts, a financial consulting business. "If there were alternatives, business owners would go there." It's a particular problem for service or information companies that don't have equipment or inventory to secure commercial loans. In testimony before the Senate Small Business Committee in April, Landis described applying for bank lines of credit and receiving credit cards instead. But relying on cards, rather than on fixed-rate loans or credit lines, can saddle small companies with unexpected and expensive debt.

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