Running a small business requires more than will and determination, sometimes it requires the kind of money that the owner simply doesn’t have yet.
A revolving credit line is a great tool to access the kind of money you need without hurting your business. Here is all you need to know about what a revolving credit line is, its benefits, how to best manage it and more.
What is a Revolving Credit Line?
A revolving line of credit is the type of loan that never ends. You are given access to a certain amount of money, and you can keep borrowing from it as long as you repay what you use.
It’s like a tank that never runs out of water given that you repump the tank after you bathe, cook or wash. So no matter what you use, everytime you pump, your tank will be replenished. That’s how a revolving line of credit works.
The most popular type of revolving credit line is the credit card, a personal loan that you can use for everyday purchases, paying bills and taking care of unexpected finances.
Other types of revolving credit lines include Home Equity Lines of Credit (HELOCs), which is a credit account for your home and Personal Lines of Credit (PLOCs), which work through credit cheques or direct deposit into your account.
How Does it Work?
For you to get a revolving line of credit, the creditors look at your business and check for things like financial history, potential, or creditworthiness to determine how much they can loan to you.
What makes the revolving line of credit great is that once you start repaying some of the borrowed amounts, the account is pumped, giving you access to the full amount again, like you never used it.
As long as you are repaying borrowed amounts you use often, your account will never run out, and the best part is that you only have to pay back interest on the amount you use, not the entire credit limit. This means that if you never use the total amount, you will never have to pay the full interest rate.
To help businesses be more accountable, the revolving credit line is open to be used for a specific period. This period is called the draw period. This is the period when you can borrow and use any amount as long as you repay, and it is usually one or two years.
After the draw period, the loaner turns any amount that is not yet paid to a business loan that requires you to pay a specific amount every month till both the loan is fully paid with interest.
Benefits of Revolving Line of Credit
- Flexible access to capital: Unlike the installment credits, when you need another loan after repaying one, you don’t have to start the application process from the beginning.
- Flexible Interest Loans: You determine the amounts you will pay in interest because interest is charged based on the money you use and not the total loan amount.
- Smooth Cash Flow: A revolving credit provides safe and consistent access to cash that helps manage expenses. This can include buying supplies, expanding costs, or making other payments.
- Creditworthiness: A well-managed revolving credit line can help your business build good creditworthiness and position you for borrowing bigger amounts when needed.
Disadvantages of Revolving Credit Line
- High-Interest Rates: The interest rates of revolving credits are usually higher than installment credit rates due to ease of access and how flexible it is.
- Unpredictable Interest: Budgeting your money can be difficult when you are not sure of how much you will need to pay in interest, since the interests are not fixed. They are determined by how much you use.
- Risks of Over-borrowing: The ease of access to big amounts in credit can put businesses at a risk of overspending, which can be a problem when it's time to pay back.
How to Optimize your Credit Score
- Spend responsibly: Try not to spend the maximum amount provided. Keep your spending limit within 30% of the credit amount to build a good credit score.
- Make Timely Payments: This indicates that you are a responsible spender and can help build a good credit score.
- Set a Budget: To avoid the risk of overspending, you should budget how much you can afford to borrow and repay.
- Stay Informed: Ensure you are well informed and constantly updated on the terms and conditions of your revolving credit line.
A revolving credit line is a great safety net for businesses to make necessary purchases, manage a smooth cash flow, take advantage of opportunities, or even take care of unexpected expenses. It’s flexible, convenient, easy to access and a great asset when managed well.