A revolving line of credit is a flexible loan option that allows businesses to borrow as needed, paying interest only on the utilized amount. With the capability to re-borrow repaid funds within the draw period, this financial tool is essential for companies needing periodic working capital or seeking to manage expenses and refinance debt.
Understanding a Revolving Line of Credit A revolving line of credit, sometimes secured by assets like real estate, is divided into a draw and a repayment period.
Draw Period: This phase allows borrowing against the credit line, with interest payments commencing upon fund usage. Any repaid amount during this period becomes available for re-borrowing. The draw period’s length varies, typically lasting one to two years, after which the lender may renew the loan.
Repayment Period: Post-draw period, the loan might require full repayment or transition into a repayment phase with fixed monthly payments covering both interest and principal.
Line of Credit vs. Revolving Line of Credit Both asset-based and typically secured, these credit lines differ mainly in flexibility. A standard line of credit doesn’t allow re-borrowing of repaid funds, making it less adaptable for dynamic business needs.
Types of Revolving Lines of Credit
- Home Equity Line of Credit (HELOC): Secured by home equity, allowing borrowing up to a significant portion of the home’s value minus mortgage balance.
- Credit Card: An unsecured form, functioning as a revolving line with repayment flexibility within the credit limit.
- Personal Line of Credit: Similar to a HELOC but secured by non-house assets or offered unsecured to highly qualified borrowers.
- Business Line of Credit: Tailored for companies, these can be bank loans or loans from alternative lenders, including the SBA, offering growth and operational finance flexibility.
Credit cards, though unsecured, are a unique form of revolving credit, often carrying higher interest rates compared to other types.
Obtaining a Revolving Line of Credit Steps include identifying collateral, selecting a credit type, choosing a lender, applying, and accepting terms. The process varies with the lender and loan type, and once approved, funds are generally accessible within days.
Pros and Cons of Revolving Credit for Business Pros:
- Interest accrues only on borrowed amounts.
- Repeated access to funds upon repayment.
- Potentially lower interest rates compared to other loans.
Cons:
- Some lines, especially unsecured ones, may have higher interest rates.
- Limited draw period duration, often requiring renewal or full repayment.
- Some lines might not convert to structured loans, necessitating full balance repayment at once.
Despite these challenges, the versatility of revolving lines of credit makes them a valuable resource for small businesses seeking to finance significant expenses for growth.