Use credit to run a biz? Be careful

Q: Steve – I would like to use my credit cards to fund my startup but my wife is really against the idea. What do you think?

— Jason

A: Plenty of people use credit cards to start businesses. Some even use them to run their businesses and keep them afloat during the lean times.

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As a former bankruptcy lawyer, I have seen too many people get in over their heads with credit cards though. That said, I have nothing against people using credit cards to start or grow a business, as long as they do it right.

The fact is, not all debt is bad debt.

Bad debt is unmanageable debt. The interest rate is too high or when you have no way or plan for paying it off. Charging a trip to Hawaii on a card with an 18 percent interest rate when you are out of work can safely be called a pretty bad debt.

On the other hand, good debt is the kind of debt you take on that makes your life better. Student loans can be a good debt. Mortgages, historically, have been good debt. In this vein, credit card debt used to start or grow a business can be an OK debt if, again, you use the cards wisely and have a plan for paying it off.

The danger, of course, is that you may fall into the credit card trap. Typically, there are two ways this can happen: First, you fail to understand what you are agreeing to when you use the credit.

So, if you are going to use a credit card to start a small business, you must know the following:

1. What is the interest rate of the card? If the card’s 4.9 percent teaser rate jumps to 16.9 percent after six months, that’s a bad deal. Moreover, any card with a rate over, say, 10 percent may be difficult to pay off (see below).

2. Is there a grace period? The grace period is the time you have to pay the money back without paying interest. It is usually between 10 and 30 days, although some cards have eliminated it altogether.

3. How do cash advances work? To get a cash advance on a credit card, you usually pay a transaction fee of around three percent per advance, and there is no grace period.

4. What about the fine print? A late fee of $52 on a card with a $100 balance is bad business (for you, not them).

The second way to fall into a credit card trap is to only pay the minimum payment every month.

Let’s say that that you have a card with a $7,000 balance, and an interest rate of 17 percent. How long do you think it will take you to pay off that balance if you pay only the typical minimum payment of 2 percent? Three years? Five years?

Let’s do the math. A monthly interest payment of 17 percent on $7,000 is $104. Adding that to your balance means that you will have a new balance in the next month of $7,104. About 2 percent of that is $142—your minimum payment. So, if you just paid the minimum, your balance the next month would start at $6,962. Thus, paying the minimum payment of $142, you only knock $38 off your original balance.

Follow this minimum payment schedule and it will take (get ready) more than 40 years to pay off the entire card, and you would also end up paying about $14,000 on your $7,000 balance.

So the lesson: Avoid this credit card trap by paying more than the minimum on you balance. How much more is up to you, but as much as you can afford.

Generally, when using credit cards in your business, you must have a basic understanding of how much money you are making and spending every month. The people I helped when I was a bankruptcy lawyer usually didn’t have a real good handle on their finances; often it intimidated them.

But they need not have worried. Handling the financial end of your business is easy these days. You can even get software that can help.

My main point here: Use credit cards in your business, but make smart choices, understand the difference between good and bad debt, and plan to pay it off soon.

How did Steve answer other questions? Read his previous columns

Steve Strauss is one of the country's leading small business experts, a columnist for USATODAY.com, and the author of the "Small Business Bible." If you would like to have Steve speak to your group, or to sign up for his free e-newsletter Small Business Success Secrets!, visit his Web site. Have a question for Steve? Send him an e-mail.