Need some quick cash for the business? After years of taking a back seat to home equity loans, plastic may be set for a comeback. The unprecedented runup in housing prices the past few years allowed many entrepreneurs to borrow against their homes. In 2006, only 11 percent of business owners relied on credit cards as their primary source of finance. But as housing prices slide maybe you’re tempted to get a shiny new business card, with zero percent interest. Before you do, better read the fine print.
Before you do, better read the fine print. More than ever, it may be loaded with booby-traps for careless borrowers. A few false steps, and you can get sucked into a spiral of debt.
“You’re putting yourself in a hole, with debt you’re going to be personally responsible for,” says John Nessel, president of the Restaurant Resource Group, financial consultants in Lexington, Massachusetts.
Over the past decade, according to a September study by the U.S. General Accounting Office, credit card companies have made up for low interest rates by pumping up fees. Ten percent of lenders’ revenues now come from penalties like late fees, which rose from an average $12.83 in 1995 to $33.64 in 2005.
Lenders have also devised a variety of new terms that make it more expensive to get out of debt. Some common clauses to watch out for:
- No grace period. You start paying interest the day you make a purchase.
- Variable interest rates. Your rate can be raised at any time, for any reason.
- Penalty pricing. Your rate goes up drastically if you’re late on a single payment. The GAO found the average penalty rate in 2005 was 27 percent.
- Universal default. Even if you pay your credit card on time, the company can raise your interest rate for being late on an electric bill.
- Unlimited fees on cash advances. Not all cards cap the fee at $50 or $75.
- Payment allocation. Say you’re paying zero percent on purchases and 20 percent on cash advances. Your payments will be applied to the low-interest balance first, leaving the high-interest balance to keep compounding.
- Transaction fees. It can cost up to $15 to make a payment by phone, or up to $13 to get a copy of a statement.
The good news is that you can sidestep many of these pitfalls by shopping for the best credit card deals online. Once you’ve got the card, charge only what you can pay off in full each month, says Brad Saltz, managing director of restaurant services for accounting firm SS&G Financial Services in Cincinnati.
“I do use credit cards for purchases,” he says. “We rack up considerable miles for firm travel and gift cards for employees under recognition programs.”
Credit cards can also help during a seasonal slump, if you’re sure you can pay them off when business picks up. “We used to get lean months in the summer,” says Christopher Perez, a former restaurateur who’s now director of Commercial Loan Capital in Warminster, Pennsylvania. “I’d use the liquidity of credit cards right before fall, when the college students would come back.”
The wrong way to use plastic is to prop up a restaurant that’s losing money, says Nessel. As interest and fees compound, you could end up like an Ohio borrower, cited by the GAO, who owed $9,056 in extra charges on a $1,963 balance.
“Ninety percent of the time you’re throwing good money after bad,” says Nessel. “Maybe it’s time to pull the plug.”