The Pros and Cons of a Revolving Line of Credit
Plus, due to the short-term and flexible nature of this type of financing, it can be a beneficial tool for your overall financial strategy. Still, it isn’t the right type of credit line for all businesses, which is why we’ll explore the pros and cons of this product.
By the end of this post, you should be able to understand how revolving credit works, and determine if it’s the right financing option for your company.
What is Revolving Credit?
A revolving line of credit is an open-ended loan that gives you access to a specific amount of cash as needed up to the credit limit. Although they’re similar to credit cards, they differ because they’re secured by business assets. In addition, they often have a lower interest rate than credit cards, and the funds can be transferred to your checking account without fees.
How Can Business Owners Use Revolving Lines of Credit?
Revolving lines of credit are ideal for seasonal businesses or companies that experience sales fluctuations. If your business has a high and low sales seasons or has a gap between completed work and payment, you may find that a revolving line of credit helps create a bridge. For example, if your business receives a large order and you need to buy inventory in order to complete it, a revolving line of credit can be an ideal way to purchase that inventory.
The Pros of a Revolving Line of Credit
1. Funds Are Readily Available
One of the advantages of having a revolving line of credit is that the funds are available whenever you need them. Therefore, you don’t need to go through an approval process to get a critical injection of cash. Instead, you’ll simply borrow from your existing line as needed.
If you think that you’ll require additional financing, plan ahead and apply for a revolving line of credit. Even if you don’t need it immediately, you’ll have peace of mind knowing that you have access to these funds.
2. The Financing Can Be Secured
Some revolving lines of credit can be asset secured in order to help lower interest rates. Unlike credit cards, which aren’t secured, revolving lines of credit can be secured based on inventory, equipment, real estate, and other valuable assets.
3. You’ll Pay Less Interest Than You Would With a Credit Card
Revolving lines of credit can be secured based on a wide range of factors. To start, you should review your credit report to determine your credit history and if it fits the lender’s requirements.
While credit scores are still a primary indicator of creditworthiness, you can also get approved for a revolving line of credit by submitting a business plan or collateral, which may result in a lower interest rate.
The Cons of Revolving Line of Credit
1. They Have Higher Interest Rates than Traditional Installment Loans
Since revolving lines of credit are flexible, they inherently carry more risk for lenders. Due to this, they often come with higher interest rates than a traditional loan. For this reason, a business loan is more favorable if you plan on using your financing to afford large purchases.
2. There Are Commitment Fees
Many revolving lines of credit carry commitment fees, which are due to the lender regardless of if you have an existing balance. With these fees, you’re securing the option to use the funds in the future. Since many other financing options don’t typically carry commitment fees, it may make more sense to apply for a different type of loan.
3. They Have Lower Credit Limits (In Comparison to Traditional Loans)
Since revolving lines of credit are usually more fluid, the approved loan amount is typically much lower than a traditional loan. If you need a substantial amount of financing, you’ll likely be better off applying for a traditional small business loan.
The advantages of a revolving credit account are mostly relevant to businesses with short-term needs; if you consistently have urgent financing needs, this could be your best option.
Of course, there are always downsides, like the ones outlined in this post. We hope that after reading our list of pros and cons, you can determine whether a revolving line of credit is right for your business.
Editor’s Note: This post was updated for accuracy and comprehensiveness in December 2020.
Editorial Note: Any opinions, analyses, reviews or recommendations expressed in this article are those of the author's alone, and have not been reviewed, approved, or otherwise endorsed by any of these entities.