Need some extra cash to get the wheels turning on your business or business project? Maybe you’re worried about depleting your cash reserves too quickly while taking a risk on a new venture. Whatever it is, there are multiple ways to secure financing for a business if needed: loans, mortgages, grants, credit, and more.
One of the easiest ways to secure financing, however, is establishing a line of credit. The application process is quicker and easier with less scrutiny. Lines of credit can be very useful for people or businesses that experience sharp fluctuations in cash balances or unexpected expenses. But there’s more than one way to access a line of credit: either as revolving or non-revolving lines of credit.
So what’s the difference between the two? What are the benefits and detractors for each? We lay that all out for you below. Keep reading!
What is a revolving line of credit?
You’re probably most familiar with this one. According to CreditCards.com, a revolving line of credit refers to a bank or merchant offering a certain amount of always available credit to an individual or corporation for an undetermined amount of time. A credit limit is established, funds can be used for a variety of purposes, interest is charged normally, and payments may be made at any time. The debt is repaid periodically and can be borrowed again once it is repaid.
Borrowing with a credit card is similar to using a revolving line of credit, with some key differences. According to Investopedia, there is no physical card required for revolving credit, and it does not require a specific purchase beforehand or at the time of borrowing. Revolving credit allows money to be transferred into a bank account for any reason. An actual transaction does not need to have been made yet. It’s very similar to a cash advance, where funds are made available up front. For this reason, revolving credit typically has significantly lower interest rates compared to credit cards.
As with any kind of financing, a bank or merchant considers several factors regarding the borrower’s ability to pay before issuing revolving credit. For organizations seeking revolving credit, a financial institution reviews the company’s balance statement, income statement, and statement of cash flows.
What is a non-revolving line of credit?
It’s very similar to a revolving line of credit; however, Investopedia puts it best: The only fundamental difference between a revolving line of credit and a non-revolving line of credit is what happens to your available funds after you have made a payment on the account.
Whereas a revolving line of credit allows the credit line to remain open regardless of when you spend or pay off your debt, a non-revolving line of credit can’t be used again after it’s paid off.
How does that work exactly? Well, non-revolving lines of credit have the same features as revolving credit with one major exception: The pool of available credit does not replenish after payments are made. Once you pay down the line of credit, the account is closed and cannot be used again.
We parse out what the similarities and differences between these two options below.
What’s appealing about both?
- Low maintenance: In short, though you need to go through some approval processes, both options are relatively low-maintenance avenues for securing financing for lower-level purchasing needs. Neither requires that the purchase or reason for credit be for anything specific. So, if you need more flexibility in your financing, lines of credit are a great way to go. Either is great for managing cash flow for relatively lower amounts of purchase power in a business that may be experiencing volatility.
- Flexible payments: With either of these, there is no set monthly payment requirement, so you can pay whenever you want to or can pay it off—to an extent. This means you can pay everything immediately if you want to—whereas something like an installment loan might penalize you for doing just that—or you can pay off the debt in an installment or minimum monthly payment to pay off larger purchases over time with interest.
- Better than credit cards: Both options have better interest rates and higher credit amounts than credit cards.
What’s less appealing about both?
- Still high risk if you can’t repay: Of course, though you have increased flexibility in terms of payment scheduling, interest accrues no matter what and will be capitalized on. It’s up to you to make sure you borrow what you can pay back and not let the interest—which tends to be a higher rate—get out of hand. Which is especially bad because….
- Higher interest: Though they have better rates than credit cards, compared to other tradition financing options, say, loans or installment loans, both revolving and non-revolving lines of credit are going to have higher interest rates because the vetting process is more lenient, thus making the risk higher (though one is better than the other in this regard—more on that in a few).
- Lower borrowing amounts: Additionally, the amount you can borrow is generally lower than what you could get with a traditional loan (again, one is slightly better than the other). This, of course, limits the kind of purchase you will be able to make—for instance, no one buys property on a line of credit because they will not be able to get a high enough credit limit sufficient to make the purchase.
So, beyond that, what are the differences, the pros and cons between the lines of credit?
Pros of a revolving line of credit
- Indefinite borrowing: Borrow what you need, when you need it, without having to reapply for financing over and over again—so long as your outstanding balance allows for it. We didn’t say infinite borrowing! This means that if you have $1,000 in revolving credit, so long as you pay off your balance every month, you’ll always have $1,000 to spend in credit month over month.
- Grow your credit: Just like a credit card, lenders of a revolving line of credit can increase your credit limit over time, allowing you to have higher purchasing power and an improved credit score.
Cons of a revolving line of credit
- Limited borrowing power: Revolving lines of credit typically have the lowest credit line amounts of the two options. Of course, if you make payment in a timely manner, creditors will likely increase this amount over time.
- Higher interest rates: Between the two lines of credit, revolving credit has higher risk associated and thus higher interest rates. Of course, if you can pay off your balance very month, this won’t be an issue.
Pros of a non-revolving line of credit
- Lower interest rates: Everyone loves better interest rates, even if it is a slight amount, and even if you pay it off every month. Managing debt is all about hedging your risk.
- Higher amounts: Because of the rigidity of the non-revolving system, lenders often lend a higher amount initially than with revolving lines of credit.
- Well-managed risk: Though the borrowing time is limited (a.k.a. not indefinite) to when the debt is paid off, that does mean it will make it easier to manage your debt risk. More limits mean less risk.
Cons of a non-revolving line of credit
- More maintenance: You’ll have to make another application and go through the approval process to borrow additional funds with a non-revolving line of credit. This can be a hassle and prevent you from getting the money when you need it quickly.
In conclusion, these flexible financing options can be great for some situations and less great for others. The first step in choosing the right kind of financing is knowing your options and understanding what you and your business need and are able to manage effectively.
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from Fundera Ledger https://www.fundera.com/blog/non-revolving-line-of-credit