Line of Credit Versus Revolving Credit: Understanding the Overlap
As a business owner, you occasionally need a financial boost. Whether you want to invest in new equipment, pay for extra marketing or just increase the amount of operating capital you have on hand, it’s important to understand the choices available so you can make the best decisions for your business. Wondering what a line of credit is exactly or trying to understand the nuances between lines of credit versus revolving credit? Here’s a look at the basics:
What is a Line of Credit?
A line of credit is a special type of loan where the lender offers the borrower a certain amount of funding, but the borrower only uses what they want up to the established limit. With a line of credit, you have access to the entire amount that has been approved, but you only spend what you need. For example, if you take out a $100,000 line of credit, you can spend anywhere from $1 to $100,000. As a result, you only pay interest on the amount you spend. This gives you a degree of flexibility and potential savings that you don’t have with other types of credit.
Both traditional and alternative lenders offer lines of credit, and there are a range of different types of lines of credit including overdraft protection, small business credit cards and demand loans as well as personal lines of credit.
Line of Credit Versus Revolving Credit
A line of credit is a type of revolving credit. Revolving refers to the fact that you can spend the money, pay it back and spend it again. This cycle continues endlessly until the borrower or lender decides to close the line.
Installment Loans: Another Option
With an installment loan, you borrow a set amount of money, and you pay it back in equal installments until the loan is paid in full. At that point, if you want to spend the money again, you need to apply for a new loan. Similarly, once you receive the initial funding, you cannot access any more credit.
Car loans, mortgages and signature loans are three of the most common types of installment loans. Both car loans and mortgages are backed by the collateral of your car and home, respectively, but a signature loan does not have any collateral. Rather than being backed by your home or car, these loans are backed by your signature, which acts as your personal promise to repay the loan. If you default on the loan, the bank does not have collateral to reclaim.
Secured and Unsecured Loans
Just as installment loans can be secured or unsecured, so too can lines of credit. The most popular example of a secured line of credit is a HELOC or home equity line of credit. With a HELOC, a borrower has access to a set amount of money, and again, they only need to spend what they need. However, unlike many other types of lines of credit, these loans are secured by the collateral of your home. In explicit terms, lenders who default on HELOCs risk losing their homes.
Collateral is just one way that lenders secure themselves from losses – another is prepayment penalties. Unfortunately, it is relatively common for installment loans to include prepayment penalties.
Here’s why: when a lender grants you an installment loan, they don’t assess all of the interest right away. Rather, the interest accrues gradually on the outstanding balance. If you pay off the loan before the term is over, the lender “loses” out on the future interest. To cut their losses, they charge prepayment penalties to borrowers who pay off the loan early.
Which Option is Right for Me?
Different financial needs and business goals align with different types of loans. If you need to make a single large purchase and you want a predictable and consistent repayment schedule, you may want an installment loan. Similarly, if you are purchasing a vehicle or a building for your business, you may prefer an installment loan because they are designed for that purpose.
However, if you want to pay different amounts every month based on the working capital you have on hand, you may prefer the flexibility of a revolving line of credit. During months with a lot of revenue, you can make large payments, and in months where funding is tight, you can make the minimum.
In addition, if you know that you need funding but you are not exactly sure how much you need, the flexibility of a line of credit is ideal. For example, if you think you need between $40,00 and $60,000 and you want a bit of wiggle room just in case, you may want to apply for an $80,000 line of credit. That provides you the flexibility to increase the amount you spend without forcing you to pay interest for any financing you don’t use.
Traditional Versus Alternative Lenders
In addition to considering lines of credit versus revolving credit and other types of loans, it’s also important to consider traditional versus alternative lenders. When deciding to grant business loans or lines of credit, traditional lenders typically look at credit scores and business plans.
Using a complex, automated and fast online system, Kabbage accesses multiple data points. That gives us a reliable snapshot of your business that stands apart from your credit score, and it allows us to offer credit to people and businesses traditional banks may overlook.
Want to learn more about lines of credit or how Kabbage loans work? Start the online application process today and access the funds you need to help your business prosper.