How Revolving Business Credit Lines Work
A revolving credit account sets a credit limit that can be spent on the account. A borrower can choose to pay off the full balance at the end of each billing cycle, or carry over a balance from one month to the next.
When a borrower revolves a balance, they will have to make a minimum payment each month. The payment amount may be a fixed amount, or a percentage of the total credit balance.
The borrower will also be charged interest on the balance that is carried over from month to month. There may also be other fees such as annual fees, origination fees or fees for missed or late payments.
Examples of revolving credit includes credit cards, personal lines of credit and home equity lines of credit. Credit cards can be used for large or small expenses, and lines of credit are often used for home remodeling or repairs.
A borrower has access to a pool of funds that they can use when needed. The borrower only has to pay interest on what they actually use.
After paying back the funds including interest over the agreed repayment schedule, the available credit balance switches back to the original credit limit.
The borrower can repeat this cycle over and over again. This is as long as they make timely payments. They do not have to reapply to keep using the revolving business line of credit.
A revolving line of credit does not require a physical product or a purchase to extend the loan. The lender will be able to transfer funds into your account any time you request them to.
When a borrower is approved for revolving credit, the bank or financial institution establishes a set credit limit that can be used repeatedly.
The revolving credit limit is approved with no expiry date. The lender may allow the agreement to continue as long as the account remains in good standing.
The lender may also raise the credit limit to encourage a borrower to spend more. Borrowers pay monthly interest on the current balance owed.
A revolving credit can come with variable interest rates that may be adjusted.
Most lenders will consider a borrower's ability to pay before setting a credit limit.
A lender may look at an individual’s credit score, current income, and employment stability.
For a business, the lender may review the company balance sheet, income statement, and cash flow statement.
A revolving business line of credit is one of the most flexible types of financing that small business owners can access for emergencies if they qualify.
Types of Revolving Lines of Credit
Short-term revolving line of credit
This has repayment terms of 18 months or less. It may be accessed by business startups and borrowers with lower credit scores. It is the most expensive.
Medium-term revolving line of credit
This has a longer term length that can range one to five years. It offers a higher loan amount but has strict qualification requirements.
A borrower needs to have a good credit score, income, and be in business for a long period to get approved.
Personal line of credit
A personal line of credit have more lenient restrictions on cash advances. It may be offered by a bank in the form of an overdraft protection plan linked to a borrower’s checking account. The overdraft must be paid back with interest.
Home equity
A home equity line of credit allows a borrower to get a loan by using a home as collateral.
Pre-approved loan amount is given based on the value of the borrower's home. The borrower only pays interest on the money used.
Credit cards
A credit card can be secured or unsecured. They are the most common form of revolving credit. Borrowers are assigned a credit limit which they can spend on their cards.
A borrower can use the credit card up to this limit, and make payments due each month to avoid interest accumulation.
Credit cards have a simple application process and are a great option for funding small business transactions.
Most cards also offer a rewards program that lets the borrower to earn points, miles, or cash back when they spend.
A borrower may need a good personal credit history to qualify depending on the credit card. Business credit cards are the best for startups and new businesses.
Collaterals used for secured revolving lines of credit
Secured business line of credit requires collateral as a condition of extending the loan. In case of default, the lender can recoup their losses by seizing and selling the assets.
There are three types of collaterals for secured revolving lines of credit for businesses including;
- Equipment
- Business Inventory
- Invoice Financing
How Revolving Credit Lines Affect Credit Scores
A revolving credit line can hurt or improve your credit scores depending on how you use them.
Making your payments on time is what will impact your credit score most. Do not miss a payment and make sure to pay your credit card balance in full each month.
You can also aim to keep the balance below 30% of your available credit. Credit scores are very sensitive to your credit utilization ratio.
To calculate your credit utilization ratio, divide your total credit card balances by your total credit limits.
Also have a mix of different types of credit. This shows that you can manage various kinds of credit to build a strong credit history.
Limit your applications for multiple credit cards or loans at the same time. When you apply for revolving credit, the lender will request your credit file from the credit rating bureaus.
This may hurt your credit score for a few months. Applying for many credit cards at the same time, suggests to credit scoring models that you are in financial trouble.
Closing a credit account even when it has no balance reduces the amount of credit you have available to you.
It may affect your credit scores by raising credit utilization ratio over 30 percent. Consider keeping the account open to help your credit score.
How to Get a Revolving Line of Credit
How can you apply for and get a revolving line of credit for your business? The first step is to find a lender who has a line of credit that you want.
Most lenders will offer the most desirable terms and rates. Once you have found the right lender for your business, you need to apply.
The main factors most lenders will consider when assessing your loan application includes;
Personal Credit Score
A lender may need you to prove that you are a reliable borrower in order to qualify for a revolving credit line.
Your personal credit history will be a strong indicator of how you will manage the business finances.
If your credit score ranges from 620 to 700, you should be able to qualify for a line of credit.
If your credit score is higher than 700, you may get a lower interest rate.
If you have lower credit scores, you may want to try getting a business credit card to build, and improve your personal and business credit.
Business duration
If you have run your business for a few years, you might qualify for higher revolving credit amounts that are less expensive.
Annual business Income
Most lenders will determine your credit limit based on how much revenue your business accrues each year.
Bank Balance
Your bank balance will help a lender to decide whether or not you qualify for a revolving credit line based on your business cash flow and profitability.
A lender may request a balance sheet or an income statement.
Uses of a revolving line of credit
A revolving line of credit is an ideal financial solution for:
- Emergency situations
- Seasonality cash flow issues and irregular revenues
- Unexpected opportunities or purchases
Advantages of Revolving Lines of Credit
Flexible
A revolving line of credit provides a fast, affordable business funding that can be used when you need it.
It gives businesses the flexibility to access money to keep their cash flow steady through seasonal fluctuations in costs and sales.
Repeat usage
The credit lines can be used repeatedly so long as the revolving credit agreement is in effect.
Lower interest
Interest on a revolving line of credit is only charged on the amount used. The borrower only pays interest on the money that is actively invested in the business.
Interest rates for business lines of credit vary depending on the credit history of the business, and a collateral used if any.
A business can keep their borrowing costs low by paying down their balances each month.
Disadvantages of Revolving Lines of Credit
Fees
Some lenders charge inactivity fees if a borrower has not used a revolving line of credit for a certain amount of time.
Some lenders also charge withdrawal fees which can range from 1 percent to 3 percent of the amount you withdraw.
Withdrawal requirements
Certain lenders may have withdrawal requirements which can be up to 10 percent.
If you plan on getting a business line of credit for future business emergencies, make sure the lender does not implement a minimum draw requirement.
Low funds
A revolving line of credit does not grant access to more funds. The maximum loan amount you can receive is around $300,000, for an unsecured business line of credit.
Higher rate of interest
This type of business financing has higher interest rates for short-term credit lines. The interest rates are often more expensive.
Secured lines of credit from banks or credit unions may be able to offer higher loan amounts and lower interest rates. They are much hard to qualify for.
A revolving credit agreement will often include a clause that allows the lender to close down or reduce a line of credit for a variety of reasons.
Revolving credit can be a risky way to borrow if not well managed. A high credit utilization rate can have a negative impact on your credit score.
Most credit experts recommend keeping this rate at 30% or below.
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