If you’re a business owner, understanding the different types of financing available for your company is critical for continuous growth.
One of these forms of funding is revolving credit. Never heard of it before? Wondering to yourself, “How does a revolving line of credit work?”
It’s a flexible type of financing that gives your company the option to borrow as much as you need up to a certain limit as many times as you need without the need to reapply.
Revolving credit lines may be a good option for certain business owners who want the assurance that they will have the financial resources they need whenever they need them.
To better understand this type of financing, let’s explore how this loan works and why it may be a good idea for your business.
What Is Revolving Credit?
So, what is a revolving line of credit?
The revolving line of credit definition is a type of loan that grants you access to a determined amount of money that you will be able to use until the maximum amount is reached.
As you continue to pay off your outstanding balance as well as any accrued interest, you will earn the chance to borrow against the same account again and again.
Many people using revolving credit will make their monthly minimum payment and bring (or revolve) the rest of the debt into the next billing period. If there is a balance on the revolving account, the next payment will likely include interest.
If revolving credit sounds foreign to you, is a credit card more familiar? Credit cards are a perfect example of one of the many types of revolving credit used in everyday life.
How Does A Revolving Line of Credit Work?
To answer the question, “How does a revolving line of credit work?” there are three components to understand: drawing money, payments, and fees.
How and when you can pull money from your line of credit will depend on your lender. Most people will put a monthly payment toward their revolving credit to continue to draw money from their account as needed. Even if the account has a balance, you can continue to withdraw money until you reach your credit limit.
Once the account balance reaches its limit, the amount will need to be paid down before you can draw money again. The account balance may include costs from purchases, balance transfer, interest, and fees.
The more you can pay off, the less you’ll be charged in interest on the money sitting in your account balance. If possible, it’s a good idea to pay off the entire bill at the same time each month.
Many revolving credit lines charge fees. For example, look out for annual fees, foreign transaction fees, origination feels, and more. Alternative financing options can you help you avoid annual fees that would typically come along with a business credit card.
Why Choose a Revolving Line of Credit For Your Small Business?
Regular costs and expenses are an integral part of running a business. Things like inventory, staff, and benefits will always need to be paid. Since many business costs are “revolving” in that they carry over from one month to the next, revolving credit can be a helpful financial resource for business owners facing regular required payments.
Here are some of the top benefits of choosing a small business revolving line of credit:
- Draw, Replace, and Draw Again When Needed – As soon as you pay back an amount you borrowed, you instantly have access to that same amount of credit again.
- Enjoy Greater Flexibility Through Immediate Cash Access – When unexpected business challenges arise, having immediate access to cash offers more flexibility of response.
- No Real Estate Assets Needed For Collateral – Unlike other secured credit sources, a revolving line of credit promissory note won’t require any real estate assets as collateral.
- Better Interest Rates – Typically, the revolving line of credit rates are lower than other types of financing.
- No Prepayment Penalties – If you want to pay your debt off early, there are no additional fees or penalties.
- Lower Cost of Capital Through Higher Control – Since you are in total control of how much you draw each time, you’ll never have to worry about borrowing more than you can handle.
- Build Credit – As you use capital from your long or short-term revolving line of credit and pay the debt back, you will build your credit score.
- Grow Credit Line – As your business grows and you prove reliable, you can grow your credit line and increase your access to funds.
Revolving Line of Credit Or Small Business Loan?
You can determine the best kind of business funding for your organization by determining what you need the funding for.
Are you expecting to have ongoing regular expenses that you will need to pay for, such as payroll or working capital? In this instance, a revolving line of credit is usually best.
Do you anticipate less frequent, larger, fixed-cost expenses that you will need to pay for? If this is the case, you would likely benefit the most from getting a small business loan, also known as a term loan. SBA loans are an excellent option.
Know the Cost: Calculate Interest
In revolving credit management, your interest will be calculated based on the days in a year. One formula is used universally to calculate the interstate on a revolving loan or line of credit, making it easy to remember no matter how much you owe or what your interest rate is.
The formula multiplies the balance by the interest rate and then again by the days per month. This total is then divided by 365 days, giving you your final answer.
Mathematically, the formula is as follows:
(Balance of the Account x Interest Rate x Days in the month) / 365 days per year = Revolving Loan Interest
How a Revolving Line of Credit Can Save Money
How does a revolving line of credit work and save you money? If you want to know how to save money with a revolving line of credit, the answer may be simpler than you may think.
Rather than calculating an estimated total amount that you may or may not need to borrow for recurring business expenses through a one-time loan, a revolving line of credit gives you the flexibility to only pay for what you borrow.
Other funding options require you to pay back the full line of credit, regardless of what you actually use. As such, a regular business loan could put you in a sticky situation if you owe more money than you actually needed to borrow and are now faced with paying it all back.
Revolving credit lines allow you to borrow and pay the money back in smaller amounts as needed, giving you greater financial control over your business and enabling you to effectively scale.
Another question to consider, how much can I get? How much is determined by many factors. ROK Financial provides lines of credit from $10,000 – $5 Million.
Before Making a Final Decision
Keep in mind that some revolving lines of credit require minimum withdrawals and include fees. Typically, revolving lines of credit have lower lending amounts than traditional business loans. You can talk to a ROK Financial advisor today and get options within seconds.