You’re always trying to find the right working capital option for your business; cutting through the marketing jargon isn’t always easy.
We’re going to explain the popular revolving line of credit and how to spot the imitations.
Before you sign up for a revolving line of credit, it’s important to know more about how this business finance tool works, what's it used for, and how you can get the best overall fit for your business as well as the most competitive rates.
What is a revolving line of credit?
Business owners get confused about the meaning of a revolving line of credit or “revolver”. Instead of taking a lump sum of money and repaying this in fixed instalments over a fixed period, a revolver is an approved set credit limit that you can draw down against, re-pay, re-draw over and over again up to the approved limit. You only ever pay interest on the outstanding balance, thus providing the most cost effective rates compared to other types of products.
For example, if your business gets approved for a $50,000 revolving line of credit, your business can borrow a total of $50,000. But you don’t have to borrow all of that money at the same time. You can borrow $50,000 at once, or you can borrow any smaller amount (whether it’s $5,000, $10,000, or more) that you need, repaying or borrowing again and again without re-applying.
With a revolver, you pay back the money you borrow on a flexible basis. There is no fixed monthly payment that you have to make and with some lenders, there is no term or period, is sometimes referred to as evergreen accounts.
For example, if you borrow $2,000 from your revolver, you can pay it back all at once with one payment the following month/day/week, or you can pay back $400 per month for 5 months (plus interest), or you can pay back $200 one month, $700 the next month, and $1,100 over the next three months, depending on your available cash flow. As long as you don’t exceed your limit you don’t ever have to re-pay principal, however, keep in the mind the interest will run on any outstanding balances so it’s best to pay down the balance when you can.
How does a revolving line of credit compare with a fixed term loan?
A revolving line of credit is an “open-ended” financing tool. That means that you have the approval to borrow as much money as you want without having to re-apply every time it's like a “just in time” finance.
Another advantage of revolvers compared to fixed-term business loans, where you would have to go to the bank or non-bank lender, talk to someone, fill out an application or get a re-assessment done, wait for your credit file to be checked again and most likely hand over some updated financials.
With fixed term loans you need to ensure you can meet the repayment obligations. Some repayment schedules are daily, weekly or monthly. If you don’t have cash available or remember to make a repayment, you can wind up in default or at least be forced to stump late fees and penalties each time you go over.
Fixed term loans are mostly suited to more of a long-term financial proposition. Fixed terms are typically used for bigger and more expensive investments in your business, such as new equipment, capital expenditures, or building a new facility.
You should keep in mind that fixed term loans have an end date. Meaning, you have a specific date by which the entire loan must be paid in full, and you can’t redraw until it’s fully paid off. You pay the same interest amount on the original amount you borrowed, instead of what’s outstanding which can be costly.
How to uncover masquerading loans
When shopping around, specifically for a revolving line of credit you can come across terms like “line of credit”, “credit line” and “unsecured business loans”. On the surface, you might not tell the difference. However, there are critical variations in how these loans work.
Remember how the “true” revolver only charged you interest on the outstanding balance allowing you to repay and re-draw at any time up to an approved limit? There are options in the marketplace that seemingly offer this solution, however when you look closely at your offer you might find that the lender provides a series of fixed term loans bundled together. Let’s say you borrow $10,000 today, then another $5,000. Loan drawdowns get treated as a separate fixed term loan with a set repayment schedule and repayment date. This significantly increases the cost of the loan compared to a “true” revolver.
Borrowing money is a fact of life for most small businesses. Sometimes you have to “spend money to make money,” and a revolving line of credit can help give your business steady access to cash when you need it most.
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