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What Is Revolving Credit?

What Is Revolving Credit?; As with other types of loans, for revolving credit products, any potential borrower must first apply for credit approval.
Lantern
LanternUpdated August 23, 2022
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How Does Revolving Credit Work?

There are several forms of revolving credit, but the underlying principle of how this type of borrowing works is the same across these products.As with other types of loans, for revolving credit products, any potential borrower must first apply for credit approval. The process is similar to applying for small business loans. Lenders will assess your creditworthiness based on factors such as credit score, income, and debt history. Once approved for revolving credit, you receive a revolving credit limit—the total amount of funds that you can draw at a given time—as well as the associated interest rate.Repayment terms are typically more flexible than the fixed payments typical of installment loans. Generally, once you’ve pulled funds, you must repay a minimum monthly amount, often based on the interest charges. But you can pay down the loan principal more flexibly, as you have the money. Until they’re repaid, the funds drawn are subject to compounding interest charges. And once paid back, the money is typically once again available to be drawn again, less costs such as interest and other bank fees, if applicable.For example, let’s say you get a personal LOC for $25,000. The first two months, you don’t use it and you pay nothing. The third month, you draw out $10,000. That means that you have $15,000 available to you and you start paying interest on the $10,000. Two months later, you pay back $5,000 of the principal. That means that you now have $20,000 still available to you and you’re paying interest on $5,000 (and will eventually have to pay back that principal). As is the case with other types of loans, the interest charged on a revolving line of credit can vary depending on factors such as credit score, whether the rate is fixed or variable, and whether or not the credit has been secured with collateral.

Revolving Credit Interest Rates Vary

Because average interest rates differ, the cost of borrowing can vary widely depending on the type of revolving credit. According to the Federal Reserve Bank of Kansas City’s Small Business Lending Survey, in the third quarter of 2020, the average rate of interest for both fixed and variable rate new business lines of credit were both around 4%. And as of May 6, 2021, the average rate on a HELOC was 6.81%. By contrast, the average APR on a business credit card is more than 14%. The timing of how that debt is paid back matters though, as a credit card that’s paid in full each month would generally be charged no interest at all, except on cash advances.

Four Examples of Revolving Credit

Here are some examples of revolving credit:

Personal Line of Credit

This form of funding is somewhat similar to a credit card. A bank or other lender grants you a certain amount of money to draw on as needed--typically up to $100,000, though it may be more. The lender will also tell you the interest rate to be paid on money that’s withdrawn. You don’t have to take out any money until you want to, and when you do, you pay interest only on your balance. While the products vary, depending on the lender, you may be given a draw period, during which you can borrow money and pay only interest. This period is typically followed by a repayment period, during which you must pay back interest and principal, typically in scheduled payments. During the draw period, if you do choose to repay principal, generally you’re able to borrow up to the credit limit again. Interest rates tend to be variable, and there may be an annual fee as well as late fees if  you miss a payment. Having a line of credit on tap may be useful if, say, you want an emergency fund.

Home Equity Line of Credit (HELOC)

This is a personal line of credit that’s secured by your home. That means that to be eligible for a HELOC, you must own a significant amount of equity in your home, and typically, you can borrow up to 85% of what your home is worth minus what you still owe for it. Since there is real estate serving as collateral, a HELOC presents less risk to the lender and may have a lower interest rate than many other kinds of loans.  HELOC interest rates may be all or partly variable. Like a personal LOC, your HELOC may be divided into a draw period of, say, ten years, during which you can take money out and pay back only interest. That’s followed by a repayment period, during which you must begin paying back principal, if you haven’t already. HELOCS may have fees associated with them, like application fees, annual fees, and early closure fees.

Business Line of Credit: 

This funding gives a small business owner access to funds that may be drawn as cash and used by the business to pay off expenses, bills, or other forms of debt. When a business is approved for a business line of credit, it may borrow up to its revolving credit limit—typically between $50,000 and $5000,000--but there’s also no obligation to do so if the business doesn’t need the funds. Interest is charged on funds drawn, meaning that if the money in a line of credit is not used, or it is paid back quickly, the cost of having funds readily available can be minimal. As with personal LOCs and HELOCs, a business line of credit may include a draw period, which specifies the allowable length of time before funds must be repaid.

Credit Cards

Credit cards are an example of revolving credit available to both individuals and businesses. Whether it’s a personal or business credit card, using plastic allows for an expenditure to be charged at the time of purchase. Your credit card issuer pays the vendor and you pay the issuer later, when your credit card statement comes due. As with a line of credit, there’s a maximum amount you can use.Interest is typically not charged on purchases until the statement due date, but if you don’t pay the balance in full, interest is charged on a daily basis and becomes part of the total balance carried forward. A failure to pay off the monthly minimum may also result in fees.If you’re trying to choose between a credit card and a line of credit, there are a few significant differences between lines of credit and credit cards:When you or your business uses a  line of credit, the funding can generally be used freely—just like cash. It can be used to buy goods, pay staff or vendors, or to pay a bill.But when you use a credit card, there may be limits on what you can do. If you’re using it for a business, some vendors and suppliers may not accept this form of payment. What’s more, expenses such as payroll, rent, and taxes may not be payable by credit card or may be subject to surcharges by third-party providers who enable such payments. And while some credit cards allow for cash advances, interest typically starts accruing from the date of the advance, not the statement date.

Alternative Options to Revolving Credit

While revolving credit can be a useful tool in some situations, there are other types of lending products you can leverage if you need funds. If you’re in need of personal funds, some alternatives you might try include:And if it’s your business that’s in need of funds, some alternatives could include:
  • SBA loans. With their generally longer repayment terms, it's a good idea to learn how SBA loans work. 
  • Merchant cash advances, which allow a business to borrow against future sales. These, however, can be costly, so it’s a good idea to fully research all of the ins and outs.
  • Equipment financing

The Takeaway

Whether you need personal funds or money to run your business, there are many opinions. Whether it’s revolving credit, a loan, or another lending product, choosing the right lending product depends on a number of factors. Lantern can help you find the right product for your needs by searching across loan types and lenders—all via a single application.
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About the Author

Lantern

Lantern

Lantern is a product comparison site that makes it easy for individuals to shop for products and compare offers with top lenders. Lantern is owned and operated by SoFi Lending Corp., the digital personal finance company that has helped over one million people get their money right.
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