Definition of a Revolving Credit
Revolving credit is a line of credit where the customer pays a commitment fee to a financial institution to borrow money and is then allowed to use the funds when needed. It usually is used for operating purposes and the amount drawn can fluctuate each month depending on the customer’s current cash flow needs. Revolving lines of credit can be taken out by corporations or individuals.
What You Need to Know About Revolving Credit
The maximum amount for a revolving credit is fixed when the financial institution, typically a bank, reaches an agreement with the customer. Along with the commitment fee, there are interest expenses for corporate borrowers and carry-forward charges for consumer accounts.
Financial institutions consider several factors about the borrower’s ability to pay before revolving credit is issued. For an individual, the factors include credit score, current income and employment stability. For an organization or company, a financial institution reviews the balance statement, income statement and statement of cash flows.
Revolving credit is useful for individuals or entities that experience sharp fluctuations in cash flow or face unexpected expenses. Because of the convenience and flexibility, a higher interest rate typically is charged on revolving credit compared to traditional installment loans. Revolving credit typically comes with variable interest rates that may be adjusted.
Various Classifications of Revolving Credit
The credit limit is the maximum amount of credit a financial institution is willing to extend to a customer seeking the funds. The most common examples of revolving credit include home equity lines of credit and personal lines of credit.
Revolving Credit vs. Installment Loan
Revolving credit differs from an installment loan, which requires a fixed number of payments over a set period of time. Revolving funds require only the payment of interest plus any applicable fees.
Revolving credit implies than a business or individual is pre-approved for a loan. A new loan application and credit reevaluation does not need to be completed upon each instance of utilization of revolving credit. Revolving credit is intended for shorter-term and smaller loans. For larger loans, financial institutions require more structure, including installation payments.
Revolving Credit vs. Credit Cards
There are numerous differences between a revolving line of credit and a business credit card. First, there is no physical card involved in using revolving credit as in the case of a credit card. Second, revolving credit does not require a purchase to be made. Revolving credit allows money to be transferred into a customer’s bank account for any reason without requiring an actual transaction for use of that money to be made. This makes revolving credit similar to a cash advance as funds are available upfront. Revolving credit also typically has significantly lower interest rates compared to credit cards.
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