The Top Pros and Cons of a Revolving Credit Line
Applying for a revolving line of credit can be a great way to borrow money for your small business, especially if you experience cash flow shortages. Typically, these funds are used to afford fluctuations in operational expenses.
In addition, 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 blog post, you should understand how revolving credit works, and determine if it’s the right business financing option for your company.
What is Revolving Credit?
A revolving line of credit is an open-ended business 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 and personal lines of credit, they differ because they’re secured by business assets.
In addition, revolving credit agreements 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.
In the upcoming sections, we’ll dive into the pros and cons of a line of credit that has a revolving limit. By weighing the pros and cons, you can determine if this is the right funding option for your business.
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 approved maximum amount of credit is available whenever needed. Therefore, you don’t need to go through a lengthy 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 business financing in the future, 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 using collateral types, such as:
- Real estate
- 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 credit line by submitting a business plan or collateral, which may result in being able to pay an interest rate that’s decreased.
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 business financing lenders. Due to this, they often come with higher interest charges than a traditional loan. For this reason, a small business loan is often 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 business 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.
Should You Pursue a Non-Revolving Credit Line Instead?
Now that we’ve reviewed how a revolving line of credit works, you may want to compare this funding option to a non-revolving line of credit.
If you apply for a non-revolving credit line, you’ll receive funding, but will have to apply for another line once you spend the funds. This differs from a revolving credit line, which doesn’t expire. If you want to avoid having to continually apply for financing, a revolving line of credit will be more beneficial to your business than a non-revolving credit line.
Conclusion: Consider a Revolving Credit Line for Your Business’s Future Financing Needs
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 February 2022.
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.