Revolving Credit: Overview and How it Works
Revolving credit facilities (also referred to as “revolvers”) provide recurring access to funds up to a designated maximum limit. The usage of borrowed funds is typically flexible, and they can be repaid over time in accordance with the financing agreement. Generally, businesses can use it for various short-term expenses, whether it be to cover operating costs or other financial emergencies.
Key Takeaways
- Funds borrowed using a revolving credit facility can be repaid and reused until maturity or renewal.
- Most types of financing associated with revolving credit have a variable interest rate.
- Its purpose is to provide access to working capital on an as-needed basis.
How revolving credit works
Revolving credit can come in a few forms, whether it be via a line of credit or credit card. What categorizes these as revolving credit facilities is that they have a predetermined borrowing limit, in which funds can be drawn or used as needed, and once repaid, can be reused again up until maturity or renewal. It can be ideal for borrowers looking to manage cash flow fluctuations, or who simply want flexible access to working capital.
In some cases, you’ll have to request a draw from the lender facilitating the loan and wait for them to deposit the funds into your account of choice. Sometimes funds can be accessed immediately, whereas some may take until the next business day. Once the request is made and funds are withdrawn, interest will accrue based only on the outstanding balance.
Since the current balance of these types of loans can fluctuate as you use them, they are usually assigned a variable interest rate as opposed to a fixed rate. This means that the cost of borrowing may change over time, depending on how often you use the credit facility.
Common types of revolving credit
There are various loan types that can be considered as revolving credit. Most commonly, this includes lines of credit, credit cards, or a HELOC. Essentially, these are all revolving credit lines that have flexible structures in which a borrower can draw funds on an as-needed basis. There are limited restrictions with how the funds can be utilized, and are generally best-suited to cover short-term expenses.
Secured vs unsecured credit
Some types of revolving credit facilities can be either secured or unsecured. For instance, a credit card typically has no collateral requirements, a line of credit can be both, and a HELOC is usually secured by the home it’s associated with. That said, it also has to do with your qualifications and the preferences of the lender.
Features of a revolving credit facility
Common features associated with a revolving credit facility include:
- Maximum amount: This is the total amount of funds available within the credit facility. The lender sets this limit; however, the limit may be adjusted upon review.
- Interest expense: Interest paid is only based on the current balance, not the total amount of the credit line. It’s also most commonly assigned a variable interest rate.
- Cash sweep: Revolving credit can often be structured with a cash sweep provision, which means that any excess cash flow will be used to repay the outstanding debt of the facility ahead of time.
- Commitment or draw fees: Some credit facilities may impose a commitment fee, even if no funds are withdrawn. In other scenarios, draw fees may be applicable with each request, although this can vary per lender.
- Reusability: Revolving credit allows a borrower to request a draw as needed, use the funds as they see fit, and repay the balance over time.
- Repayment term: Some forms of revolving credit have open-ended usability, whereas others may have a maturity date and can be renewed upon approval.
- Accessibility: Most forms of revolving credit are now more accessible than ever. Notably, fintech advancements now make these types of financing easy to facilitate, and allow businesses to request draws and manage their finances at the touch of a button.
Pros and cons of revolving credit
Revolving credit vs installment debt
Revolving credit differs from installment debt in that there are no set repayment amounts or lump sum funding. With an installment loan, you’d be provided with lump sum funds, which you would pay down over time, usually with monthly principal and interest payments. With a revolving credit facility, you only repay the current balance and accrued interest. The repayment schedule can vary based on the current balance and whether you are expected to make daily, weekly, or monthly payments.
How businesses can use revolving credit
Businesses may benefit from using revolving credit in a few ways. That said, here are some scenarios in which businesses can best leverage a revolving credit facility:
- Using funds for short-term expenses: Revolving credit can provide for flexible capital needs, and allow a business to maintain operations if they are subjected to gaps in cash flow, emergency expenses, or have other short-term financing needs to sustain their business.
- Meeting seasonal operating needs: For businesses that operate seasonally, revolving credit can allow you to purchase inventory, keep up with payroll, and ensure you can take care of any emergency situations without hindering your operations.
- Taking advantage of growth or expansion opportunities: A business can use revolving credit to grow their business, as it can provide quick access to capital to jump on acquisition or expansion opportunities. This can include opening new locations, expanding inventory, or creating new products.
How to get a revolving credit facility
As there are different types of revolving credit, qualifications and loan details will differ based on your creditworthiness and the requirements of the provider. When getting a revolving credit facility, a few common considerations can include annual income, time in business, and credit score.
Before submitting an application, be sure to factor in your current credit utilization, cash reserves, and your budget to ensure you can meet further debt obligations.
Where to get revolving credit
Depending on the type of revolving credit you’re looking to get, there are a few options when going about where to find a provider. For a line of credit or HELOC, these are commonly issued by banks, credit unions, or online lenders. Credit cards can also be obtained through these types of financial institutions; however, they are more popular among institutions that specialize in this area.
Frequently asked questions (FAQs)
Some examples of revolving credit can include a line of credit, a HELOC, or a credit card. Essentially, it’s any form of financing that can be reused and repaid over time, rather than being issued a lump sum of funds all at once.
Not if you manage them properly. If you’re consistently missing payments, not considering your credit utilization ratio, or violating other terms or conditions outlined in your financing agreement, the lender may take action that can impact your credit. It’s important to stay on top of your finances and meet your obligations as needed.
Yes. In fact, in most cases it’s expected that you repay the balance in full by the end of the loan term. You may be obligated to make daily, weekly, or monthly payments depending on the type of revolving credit facility you have.
