Revolving vs. Non-Revolving Lines of Credit
In this post, we’ll discuss two types of lines of credit: revolving and non-revolving. Both options serve different needs, and have their own interest rates, limits, terms, and application requirements. After reading this post, you’ll be able to determine which option is right for your business.
Revolving Line of Credit
A revolving line of credit is like a credit card. Once opened, you can spend up to the credit limit. If credit is available, you can continue making purchases, and if you don’t use the line, it doesn’t expire or close. Each use of credit on a revolving line is referred to as a draw. The amount of the draw is deposited into your checking account, and can be used as you like. Funds are available quickly once a draw is initiated, and you can make a draw and have the funds in your account within minutes. Each draw subtracts from available credit, limiting the amount that can be drawn until outstanding draws are paid back.
As you can see, revolving lines of credit offer a lot of flexibility, and are beneficial if you need to fulfill cash flow shortages, or make numerous small purchases over a period.
The following is an example of making several draws from a $10,000 line:
1/14 – $2000 (available credit $8000)
1/16 – $500 (available credit $7500)
1/20 – $1000 (available credit $6500)
1/25 + $200 (Monthly minimum payment. Available credit $6700)
In this example, the credit line can be drawn down further after the 1/25 payment. The example is simple, and does not show the impact of interest, which will also reduce available credit.
It is important to note that Interest rates on revolving lines are higher than non-revolving lines of credit, but not as much as credit card interest rates. This can make a revolving line a more efficient use of funds over using credit cards, especially if the balance is not paid in full.
Interest rates are often variable. Most revolving lines of credit structure their interest rates on the prime rate plus an amount determined by the lender. As the prime rate goes up, your interest rate increases by a similar amount. As the prime rate decreases, so will your interest rate.
In addition, the credit limit on a revolving line of credit will be smaller than a non-revolving line. Depending on your needs, this can mean limited access to capital.
Non-Revolving Line of Credit
Like a car loan, a non-revolving line of credit is a lump sum paid at once. For example, a business loan is a type of non-revolving line of credit.
These types of lines have lower monthly payments than non-revolving lines of credit. Interest rates are also lower and usually fixed, so they aren’t going to fluctuate on a monthly or even yearly basis, unless there is a special condition included in the loan terms.
Like a revolving line of credit, you must complete an application to receive a non-revolving line of credit. The difference is that once the non-revolving line has been paid off, the account is closed. If you want to open another non-revolving line of credit, you must apply again. In addition, this means there will be additional inquiries on your credit report, which will impact your score.
If you’re in need of fast financing, a non-revolving line of credit might not be your best option. Since there is an application process involved with each new non-revolving credit line, you won’t have quick access to funds. Also, if you only need financing for small transactions, you might also consider a different financing option. Non-revolving lines of credit are made in a lump sum, making them beneficial for businesses who need to make large purchases, or are investing in something like an expansion project.
One thing to note is that non-revolving lines of credit allow for better expenditure projections, since you know exactly how much the loan will cost and when it will be paid off before you sign the papers. This is not the case with revolving lines. In addition, some non-revolving lines of credit will include a prepayment penalty in their terms. This means you must adhere to the amortized schedule and pay off the loan on the listed terms.
In summary, the choice between a revolving vs. non-revolving line of credit will depend on your needs. Funding frequent small transactions are great for a revolving line because it doesn’t require an application process every time you need access to new funds.
For large capital purchases, a non-revolving line is the best choice. It has lower monthly payments, and a fixed, lower interest rate.
We hope that after reading this post, you can decide on a line of credit option that is right for your small business!
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.