What is a revolving line of credit, and how does it work?
It is impossible to run a business without a solid flow of money. Also, whenever your business has to make a big spend, you cannot just keep issuing new credit cards. Along with having a negative effect on your credit score, it will also make credit management hell. Having either alternate streams of business income or having access to the right kind of funds is essential. Multiple businesses fail to make it in the long term due to the lack of funds.
This is where a revolving line of credit comes into the picture. It can be an alternative financing method to help the business stay afloat in imbalanced times. The application process and working of a revolving line of credit differs from the traditional loan types.
What is a revolving line of credit?
When a business avails of a revolving line of credit, it can use that line to a maximum credit limit. This means that the provider sets a maximum credit limit up to which a business can borrow money.
Companies can use the funds in small portions and keep repaying the amount. The remaining amount can again be used and revolved till the next billing period. Another way to repay is all at once. Whatever amount the business has borrowed can be repaid as one bug amount.
Different types of revolving lines of credit
To get a secure business line of credit, the business is supposed to submit some kind of collateral. Business assets can be used as collateral to open a credit account.
A secured business line of credit is generally easier to get and is offered at lower interest rates than the unsecured ones. This is because if, for some reason, you are unable to repay the loan, the collateral can be used as a repayment.
Along with this, the collateral value is a factor considered in deciding the credit limit.
An unsecured business line of credit can only be obtained by analyzing your company eligibility, rates, and credit score.
Here again, there is a maximum credit limit set by the issuer. The interest on this line of credit arises as soon as you borrow from the credit line.
Some unsecured business lines of credit have a set minimum withdrawal requirement and monthly payment fees to keep the account active. Others have an initial draw period. This means you can make multiple withdrawals and pay the interest on it. Once the draw period ends, you cannot borrow any more money.
Business credit cards are convenient to make purchases, transfer money, or even take cash advances. Every month you are supposed to pay a minimum fee to keep your account active and show the vendor that you can pay your bills.
If you are able to pay all the balances in full, the interest amount is not charged in most cases. The unsecured and secured credit card is the same as the credit line. You have to pay a certain refundable security amount to get a credit card if your scores are low. And an unsecured credit card can be availed on the basis of a good business credit score.
How does a revolving line of credit work?
1. Apply for credit with a lender
Unlike traditional loans, revolving lines of credit are a continuous funding source. Step one is to apply for a revolving credit line with a lender. Some providers allow applying online, whereas some require the business owner to come to the office and provide identity and business proof for the application.
2. Setting up the credit account if the credit is approved
Once the credit request is approved, some documents and formalities have to be completed in order to set up and activate the credit account. Many providers set an amount to be withdrawn each month to keep the account active.
When you get the account, make sure to check and store all details and give your employees adequate information for using the account.
3. Access the funds
After the account is set up, you get a physical card or a virtual card number to access the funds. You can give these corporate cards to your employees to access the funds or get them to withdraw cash or draw cheques to make payments.
4. Repay the credit
Every credit provider has different repayment methods. Some ask for monthly repayments with interest, some ask for one-shot repayment without interest charge, and some charge an annual interest on the withdrawn amount, etc.
5. Revolving credit
Once the borrowed amount is repaid with interest or without interest (for some providers), the amount of the loan is renewed or available again. The amount is available again for use. You do not have to apply for a new credit line or credit card.
Advantages of revolving line of credit
1. Funds are promptly accessible
One of the upsides of having a revolving credit line is that credit is accessible at whatever point, as required.
As a result, you won't have to wait long for approval before receiving a crucial cash injection. Bearing in mind the situation, you'll get from your current line on a case-by-case basis.
Plan ahead and apply for a revolving line of credit if you anticipate needing more business financing in the future. Regardless of whether you really want it right away, you'll enjoy the security.
2. It is possible to secure funding through assets
In order to assist in lowering interest rates, some revolving credit lines can be secured by assets. Revolving lines of credit, in contrast to secured credit cards, can be secured with various forms of collateral, like stock, land, equipment, and other significant resources.
Startups can also raise funds through crowdfunding. Read our article on the best crowdfunding platforms for startups to know in detail the different types of crowdfunding options available for startups and the best platforms to raise funds.
3. You won't have to pay as much interest as you would on a credit card
A wide range of factors can be used to secure revolving credit lines. To begin, you should look at your credit report to see if your credit history meets the requirements of the lender.
You can get approved for a revolving credit line by submitting a business plan or collateral, which may enable you to pay a lower interest rate, despite the fact that credit scores remain the primary indicator of creditworthiness.
4. Avoid paying for things you don't use
You don't have to pay for the entire amount of your credit line borrowed, unlike other funding options. You can have a good sense of safety, realizing you have accessible assets to draw from, regardless of whether you're not utilizing them.
5. Develop your credit line as your business develops
Banks take a rigid and frustratingly slow way to deal with growing credit lines, as mentioned by entrepreneurs.
Fortunately, revolving credit lines are constantly being evaluated to ensure that business owners are eligible for credit line expansion as their operations expand.
Disadvantages of revolving line of credit
1. Higher interest rates in comparison to traditional loans
Revolving lines of credit carry more risk for lenders of business financing because of their flexibility. Because of this, they frequently accompany higher interest charges than customary credit.
Consequently, if you intend to use the money you get from a small business loan to pay for large purchases, it is often more advantageous.
Check out our article on startup business loans to know some of the schemes that startups can apply for in order to get collateral-free business loans.
2. Commitment fees
A lot of revolving lines of credit have commitment fees that you have to pay the business lender, even if you have a balance. You are securing the option to utilize the funds in the future by paying these fees. It may be more practical to apply and consider different kinds of loans because many other options for financing typically do not have commitment fees.
3. They have lower credit limits than traditional loans
Revolving lines of credit typically have much lower approved loan amounts than traditional loans due to their greater flexibility. If you need a lot of money, apply for a traditional small business loan.
4. Overspending
Numerous people tend to overspend on a revolving credit line in light of the enticement of having more cash to spend than they can cover. You may be tempted to purchase more than you require.
On the off chance that you access the primary installments expected on a revolving credit line, you might think you’re only setting aside some extra cash. But you'll pay a lot more in interest in the long run.
How to qualify for a revolving line of credit
The prerequisites rely upon the moneylender you pick, so do a thorough exploration of the bank you are keen on.
In most cases, in order to demonstrate your capacity to repay the loan, you will be required to prepare the cash flow statement, income statement, and balance sheet for your business. Put together the necessary paperwork and send in your application.
These days, most applications for a revolving credit line should be internet based on the bank’s site. Before accepting and closing on your loan, which may involve signing an agreement, you will be given a term sheet to review, if you qualify for a revolving line of credit.