What Is a Revolving Line of Credit?

What is a revolving line of credit?

A revolving line of credit is a loan typically secured by real estate or other collateral – but not always. When you receive a revolving line of credit, the line is divided into two parts: a draw period and a repayment period.

• Draw period: During the draw period, you can borrow money against your line of credit. You won’t start paying interest until after you borrow against your line, and then you would make interest-only payments, which typically occur monthly. If you make extra payments – reducing the outstanding balance – you can borrow that money again during the draw period. The draw period varies by the lender. However, it usually ends after one or two years. At that time, the lender may decide to renew your loan, extending the draw period.
• Repayment period: At the end of the draw period, if the loan isn’t renewed, the lender may call the loan, in which case you must repay it in full. Most often, the loan enters a repayment period. At this point, the lender converts any outstanding balance to a structured business loan paid back through fixed monthly payments composed of interest and principal.

Line of credit vs. revolving line of credit

A line of credit and a revolving line of credit have similarities and differences. Both are asset-based loans typically secured by property or another asset. Both options charge interest only on the money you borrow for your company against the line, and you are responsible for interest-only payments on the outstanding balance.

The biggest difference between a line of credit and a revolving line of credit is that a revolving line allows you to reborrow any money you use against the line and subsequently pay back during the draw period. A line of credit that isn’t revolving does not have this feature.

Because a nonrevolving line of credit does not allow you to borrow the same funds a second time, this may also impact the length and structure of the loan’s draw period. It also makes the line inherently less flexible for your business needs.

Types of revolving lines of credit

Though a revolving line of credit is a fairly specific loan class, these are some typical types of revolving lines of credit. Most are relatively similar and require pledging collateral worth more than the loan amount – but not all of them.

• Home equity line of credit (HELOC): A HELOC is secured by the equity you have in your residence – the home’s value above your mortgage balance. You qualify for a HELOC if you have over 20 percent equity in your home; you can borrow 85 percent or 90 percent of the home’s total value minus any outstanding balance on your primary mortgage.
• Credit card: Though they aren’t secured – and most people don’t think of them as such – business credit cards are technically revolving lines of credit. As long as you make minimum payments monthly, you can pay off the items you charge for your business – within your credit limit – on your own schedule.
• Personal line of credit: A personal line of credit is similar to a HELOC, except it’s secured by assets other than a house. Most personal lines of credit are secured, but some lenders provide unsecured lines of credit to highly qualified borrowers.
• Business line of credit: A business line of credit is a standard loan in the industry. They can be bank loans or loans issued by alternative lenders and the SBA. In fact, these lines of credit are often one of the best business loans companies can acquire, because they grant the flexibility to cover seasonal expenses or finance growth.

While most of these examples are similar, credit cards stand out. Though they are technically revolving lines of credit, funds borrowed with credit cards are almost always unsecured loans (except for secured options). Because of this, credit cards have higher interest rates than other types of revolving credit lines.

How do you get a revolving line of credit?

These are the steps for obtaining a line of credit:

1. Identify potential collateral. Before looking for a lender, the first step in attaining a line of credit is considering what assets you can pledge as collateral on a loan. If you can find collateral to secure a loan, you’ll be able to secure much more favorable terms.
2. Choose a type of line. Once you determine what collateral you have to pledge, you can decide whether you want to get a HELOC, personal line or credit card. If you’ve been in operation for at least two years, you’ll probably want a business line of credit.
3. Pick a lender. Different lenders specialize in different types of loans. If you want an unsecured business line of credit, online lenders can help. They may charge higher interest than you might pay on a secured line of credit, but you should be able to get your money fast after a short application process.
4. Apply. Applications vary by lender and loan type. Some can be completed online, while others involve reviewing documents with a loan officer or meeting with a private banker or credit union representative.
5. Accept terms and close. If you qualify for a line of credit, your lender will provide a loan contract term sheet you must review before accepting terms and closing on your loan. This may involve signing a lien agreement pledging certain property as collateral.

Once you close on a line of credit, you should have access to funds within a few days. Some online lenders may take a few days to wire funds to your bank account, but some offer funds as quickly as the same day the loan documents are executed.

Pros and cons of revolving credit for business

As with many small business financial management options, a revolving line of credit has upsides and downsides. 

Pros of a revolving line of credit include the following: 

• You don’t pay interest until you draw funds against the line.
• You pay interest only on the money you borrow.
• The money is available repeatedly once you pay down the balance.
• A line of credit may have a lower interest rate than other loan types.

Cons of a revolving line of credit include the following: 

• Some lines, including unsecured lines, charge higher interest rates than secured lines and other types of loans.
• The draw period when you borrow against the line typically lasts 12 or 24 months; then the loan must either be renewed – for a fee – or paid in full.
• A line may not be convertible to a structured loan for repayment. You may have to pay back the full balance all at once if the lender won’t renew and you can’t find another lender to refinance the balance.

Despite these drawbacks, revolving lines of credit have many advantages that make them ideal for small business owners. Using revolving lines of credit, you can finance outsized expenses that will grow your company.

Credit that revolves around you

Revolving credit lines are among the most flexible forms of small business funding; you can use them virtually however you please. For starters, you never have to use the entire credit line, and you pay interest only on the funds you actually use. On top of that, there are virtually no rules against using credit line funds for specific purchase categories. The only real limit is the size of the line. Many lines are too small for, say, a commercial real estate purchase. Otherwise, business credit lines work entirely for you, entirely on your terms.

Max Freedman contributed to this article.