Can't Live Without Credit Cards? Here's How to Live with Them

Small businesses are hooked on plastic. Credit cards are now the No. 1 source of small business financing, but on the downside, more than 70 percent of business owners carry a month-to-month balance. For many, it's a love-hate relationship. But lately it's grown to become more of the latter and less of the former.

A majority of small business owners (53 percent) say their credit card terms have grown worse over the past five years, according to a recent survey by the National Small Business Association (NSBA). The Washington, D.C., group has become a leading advocate for credit card reform on Capitol Hill, where bills are pending to change some controversial industry practices.

The issue has been on the front burner in Congress since early last year. Congressional interest was sparked by a 2006 Government Accountability Office (GAO) report that called for reforms and by small business complaints. Committees in the House and Senate held hearings over the summer, and last month Sen. Claire McCaskill, D-Mo., reasserted that she would press ahead with "meaningful credit card reform."

Whether Congress acts on the legislation before it adjourns later this year is open to question. But with the nation suffering through the subprime mortgage meltdown, some experts warn that a consumer credit crunch could be next. Americans hold more than $900 billion in credit card debt (about $2,200 per household). Defaults increased by 30 percent during the first six months last year on the heels of a 66 percent surge in bankruptcies in the first quarter of 2006. Much of that was attributed to the subprime crisis. As a result, the issue could spill over into the presidential elections.

Small businesses face a particular problem because access to capital has always been a problem, especially for startups and businesses based on intellectual rather than tangible assets, the latter of which can be used to secure credit. Up until the early 1990s, however, only about 16 percent of small business owners used credit cards for capital. But in the latest NSBA survey, more than 44 percent said they had used credit cards for financing over the preceding year. What's more, 71 percent carry a month-to-month balance, up from 64 percent in 2000. Of those, 13 percent are carrying more than $25,000 in credit card debt, and 36 percent are carrying more than $10,000, according to the survey.

A number of factors have contributed to the trend, among them, the decline of small regional banks and a tightening of credit standards. So, in a sense, the easy availability of credit cards has been a godsend. Without them, many small businesses would have no line of credit at all to finance purchases or cover cash flow shortfalls. That's the love part.

The problem arises because many small businesses say credit terms have become increasingly burdensome, often change without notice, and are poorly disclosed or difficult to understand. In fact, the 2006 GAO study found that required disclosures often were poorly organized and important information was either buried in text or scattered in numerous unrelated places. According to one report, the average disclosure now runs about 30 pages.

But poor disclosure is only part of the problem. "America's entrepreneurs are not naïve or uniformed consumers. They are accustomed to dealing with myriad complex financial and regulatory frameworks," said Marilyn Landis, a finance consultant who testified on behalf of the NSBA. "The current rules -- such as they are -- governing the credit card industry are simply stacked against them."

The problems are exacerbated because "there is no longer real competition in the credit card industry," Landis asserted. Indeed, the three largest credit card issuers control 61.8 percent of the market (as measured by outstanding credit debt), and the top 10 issuers control about 88 percent. "One of the basic tenets of free-market capitalism is the sanctity and insolubility of contracts, but somehow the credit card industry has managed to insulate itself from adherence to this basic principle, retaining the right to unilaterally change the conditions of their contracts," she testified.

Most small business owners are unlikely to cut up their credit cards. But it is possible to restore some of the love by finding cards that don't have the so-called "tricks and traps" that put the bite on your finances. Here are some to avoid:

• Universal Default: A card issuer increases your interest rate if you are late on an unrelated payment to a different credit card company, a utility company, or a mortgage lender, even though it may be unrelated to your business.
• Double-Cycle Billing: A card issuer charges interest on the entire original balance, even part of that balance that was subject to an interest-free period and may have been paid off in part.
• Retroactive Fee Increases: A card issuers applies interest rate increases or penalty rates not only on new charges, but also on previous charges as well. According to the Consumer Federation of America, no other industry in the country is allowed to increase the price of a product once it is purchased.
• Interest on Transaction Fees: Some card issuers not only charge interest on purchases but also on the fees they tack onto the bill.
• Selective Application of Payments: Some issuers apply a customer's payments to the card balance with the lowest interest rate first, instead of the highest rate.

Although credit card disclosure statements may be tough to decipher, you can call the credit card company directly and ask about these practices. You can also go to a number of consumer credit Web sites, such as LowCards.com or CardRatings.com to comparison shop. Small businesses may be hooked on plastic, but owners may find that they still have the power to shape the relationship if they ask the right questions.