Whatever its form, a line of credit is a valuable tool that helps businesses and individuals embark on their entrepreneurial journeys with an economic advantage. However, many potential clients do not know what it is that makes a revolving line of credit different from all the others.
In essence, a line of credit that revolves is a more direct and practical form of credit. In order to help you understand what this means, the present guide will go over the main features of a revolving line of credit, as well as its differences with a regular line of credit.
What Is a Revolving Line of Credit?
At its most basic, a revolving line of credit is a specific type of arrangement between a lending institution and a business or individual. Much like other kinds of credit lines, this type of credit line sees lenders giving its clients access to funds that they can use at their discretion to make purchases. The institutions will grant a maximum credit limit that you can use to make any kind of business transaction.
Most borrowers, however, use it to finance capital expansion. People often use it to solve cash flow problems. As a matter of fact, this type of credit is often used to help small businesses buy more inventory, comply with payroll duties and pay the bills while waiting for money to arrive from slow-paying customers.
How Does a Revolving Line of Credit Work?
One of the main features of a revolving line of credit is that its limit can be extended by the lending institution. Anyone who has owned a credit card knows how this type of system usually works. Whether you receive the credit extension or not depends on the consistency of the payments.
There is no set date (be it monthly or otherwise) for revolving credit account payments. Still, their interests accumulate and become capitalized the same way it happens with other types of credit. The account’s funds become available for borrowing again as soon as payments are made for the previously spent capital.
How Can a Revolving Line of Credit Work Be Used?
Another way in which this form of credit differentiates itself from other types of loans is the declaration of purpose. One should note that other types of loans such as mortgages, auto loans, and student loans are only granted when the client can prove that he/she will use them for specific purposes.
In addition, traditional types of loans require clients to pay a set amount of money on a monthly basis. In contrast, a revolving line of credit does not require clients to give a declaration of purpose or comply with a monthly payment.
Secure vs. Insecure Lines of Credit
Any revolving line of credit comes in either a secured or an unsecured version. A financial institution will grant a secured line of credit that revolves only when it goes against a tangible asset as collateral. For that reason, interest rates tend to be much lower on secured revolving line credit accounts.
On the other hand, unsecured revolving lines of credit accounts are given without a payment guarantee, performance guarantee, satisfaction guarantee or opportunity for return from the recipient. It goes without saying that the latter type of credit is much riskier for the lender. Also, it often results in very high-interest rates.
Main Differences: Revolving Line of Credit vs. Regular Line of Credit
What Is a Regular Line of Credit?
A regular line of credit possesses all the characteristics that were mentioned before. It happens whenever a lending institution grants an amount of spending money to an individual or a business. One must make payments for the regular credit line based on the amount that he/she has originally borrowed with the addition of an interest charge that responds to the overall balance.
However, the bank will not reinstitute a regular line of credit once you paid it off.
A regular line of credit functions in accordance with a payment schedule and a fixed interest rate. We should also mention that a regular line of credit normally has much lower interest rates. On the other hand, one should use regular lines of credit for specific purposes. This aspect makes them much less flexible and practically unusable for certain business enterprises.
Something important to mention about regular credit lines is that they give clients the choice of either repaying the amount over a period of time or immediately. Of course, immediate payment translates to lower interest fees. However convenient it may be, a regular line of credit does not always work for small businesses or individuals. This happens because these entities need to use the money for several different purposes.
How Is a Revolving Line of Credit Different from a Regular Line of Credit?
It’s true that a regular line of credit has many advantages. However, it does not possess the flexibility of a revolving line of credit. It helps clients deal with definite types of credit needs. Therefore, businesses or individuals cannot use a regular line of credit to satisfy their most pressing needs.
As a matter of fact, even the most accommodating lines of regular credit require clients to re-apply every time they need more money. There’s also another difference between a regular and a revolving line of credit. You can use the latter for short-term purchases and expenses. This makes it much more practical for the needs of small businesses and individuals.
Summing It Up
Broadly speaking, we can say that a revolving line of credit is a more flexible line of credit. Its flexibility comes from its purpose and payment schedules. Even though it may seem otherwise, this difference is hugely important for small business owners and individuals.
It is particularly helpful for small business owners who need money to keep a regular cash flow going through at all times. Have you ever tried this form of credit line? Please, let us know in the comments!