The Ultimate Guide to Revolving Lines of Credit

Updated on June 4, 2020
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What Is a Revolving Line of Credit?

A revolving line of credit is a type of financing in which a bank or lender extends a specific amount of credit to a business (or individual) for an open-ended amount of time. This credit line can be drawn upon as needed with the debt paid back over a period of time—once the debt is paid, the limit resets, and the line can be drawn on again.

If you’re looking for financing for your small business, you may have come across revolving credit in one form or another. Whether a line of credit or a business credit card, there are a variety of revolving credit options for small business owners—and these products are great if you want funding options that are more flexible than traditional business loans.

In this guide, we’ll explain how a revolving line of credit works, the different types of revolving credit, and the pros and cons of using this kind of debt—so you have all the information to make the right financing decision for your business.

The Ultimate Guide to Revolving Lines of Credit

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How Does a Revolving Line of Credit Work?

A revolving line of credit, also referred to as “revolving credit” or “revolving credit facility,” functions very similarly to the way a credit card works.

With a revolving line of credit, borrowers have access to a pool of funds that they can use as needed. The borrower doesn’t have to use the entire amount of credit they have access to, and they’ll only have to pay interest on what they actually use. After paying back the funds, plus interest, over an agreed-upon repayment schedule, the available credit balance goes back up to its original limit—that’s where the term “revolving” comes from.

You can repeat this cycle over and over again, just as you would when you use and pay back a credit card. As long as you make timely payments, you don’t have to reapply to keep using your revolving business line of credit.

Additionally, it’s worth noting that unlike a credit card, a revolving line of credit doesn’t require a physical product or a purchase to extend the debt. Instead, the lender will be able to transfer the funds into your business bank account any time you request them—also called “drawing on the line.”

This being said, you can draw money from a revolving line of credit for any purpose—whether to pay for inventory, make payroll, or to cover other expenses during a slow business period.

    What is an example of a revolving line of credit?

    Now that we have an overall understanding of what a revolving line of credit is, let’s break down a specific example to get a better sense of how it works:

    Let’s say you apply for a revolving line of credit, and you qualify for $50,000. You don’t need to use that capital right away, so you don’t withdraw any funds—you just keep this line of credit in the back of your mind.

    A week later, however, you receive a large order that you need to purchase additional inventory for—this is a perfect opportunity to tap into your revolving line of credit.

    To pay for the inventory, you draw $10,000 from your line of credit. The remaining $40,000 stays available in your pool of funds.

    Once you pay that $10,000 back (plus interest charges), you’ll have that entire pool of $50,000 back at your disposal. If your agreement is a true revolving credit agreement, you won’t need to reapply or re-confirm your agreement with your small business lender. Once you’ve paid back what you owe (on time, in full, plus interest), your revolving credit funds are free to use again.

What Is the Difference Between a Line of Credit and a Revolving Line of Credit?

Although a traditional line of credit, or a non-revolving line of credit, is different from a revolving line of credit, the two have an inherent similarity: Both of these business financing products give you access to a pool of funds that you can draw on and repay as you need to—only paying interest on the amount you draw.

However, the distinction between revolving vs. non-revolving lines of credit lies in what happens after you’ve drawn, used, and fully repaid the funds.

Unlike a revolving line of credit, where you can continue to use the pool of funds up to your maximum amount after you’ve repaid what you’ve borrowed, a non-revolving line of credit doesn’t replenish once you repay what you borrowed. Instead, once you’ve depleted all the funds and paid back your balance, your lender will close your account. In many cases, you’ll have to reapply to have access to funds again.

Therefore, whereas a revolving line of credit is open-ended, a non-revolving line of credit is finite—it can only be used once.

In this way, you might find that non-revolving lines of credit are available in larger amounts and at lower interest rates compared to their revolving counterparts. Essentially, the limitations involved with a non-revolving line of credit means less risk for the lender—and therefore, they may be willing to extend more credit, and at a lower rate.

Types of Business Revolving Lines of Credit

So, what types of revolving lines of credit are available to small business owners?

Ultimately, there are a few options and they vary in terms of repayment period, interest rates, and qualification requirements.

This being said, however, these products will offer some of the most flexible financing on the market, and therefore, are certainly worth considering for your business needs.

Let’s learn more.

1. Short-Term Revolving Line of Credit

A short-term revolving line of credit has repayment terms of 18 months or less.

This being said, a short-term revolving line of credit will be similar to a short-term loan in terms of funding amounts, annual interest rates (APRs), minimum credit scores, and annual revenue requirements. Generally speaking, these products can offer amounts of up to $250,000 and APRs that range from 8.5% to 80%.

Compared to other lines of credit, short-term revolving lines of credit may be more accessible for startups and business owners with lower credit scores. Although it is possible to get a business revolving line of credit from a traditional bank, online lenders like Kabbage and OnDeck will offer the most accessible (but also more expensive) options.

Moreover, if you do apply for a short-term revolving line of credit, you can expect an easier and faster approval process than you would with other loans or even other lines of credit. But as always, fast capital is expensive capital: A short-term revolving line of credit will be the most expensive revolving credit product on the market.

2. Medium-Term Revolving Line of Credit

A medium-term revolving line of credit has a longer term length, as the name implies, than a short-term revolving line of credit. These products can have a term length ranging from one to five years.

Additionally, these options come with higher loan amounts: Credit limits for medium-term business revolving lines of credit can sometimes reach as high as seven figures. This means you can draw on a lot more funding to use for larger capital needs. But, as with short-term vs. longer-term loans, access to more money with a medium-term revolving line of credit means stricter qualification requirements.

On the whole, to access a medium-term revolving line of credit, you’ll need a good credit score (over 600), strong business revenue, and a longer time in business. Plus, you’ll likely need to spend more time collecting documents for your application, and lenders will spend more time processing them. In this way, medium-term revolving lines of credit are not as fast to fund as their short-term counterparts.

This being said, however, by taking the time to apply for a medium-term revolving line of credit (and, of course, having the credentials to qualify for one), you’ll access the benefits of the longer repayment term. Having longer to pay back the funds you draw from your credit line will mean lower rates and less-frequent payments.

Once again, you may be able to access a medium-term revolving line of credit from a bank, which will offer the most desirable rates and terms. If you can’t qualify for a bank line of credit, however, you can explore alternative lenders like Fundation, which offers these medium-term products.

3. Business Credit Card

Although not exactly the same as a line of credit, business credit cards do offer a form of revolving credit.

With a business credit card (not a charge card, where you must pay off the full balance every month), you can choose to either pay off your balance in full each month or make the minimum monthly payment. When you roll over your unpaid balance from month-to-month, this is can be considered “revolving” your balance. As you may already know, interest will then accumulate on the balance that you don’t pay off each month.

Once you pay off your balance, however, the limit on your credit card will replenish, and you’ll be free to spend up to that amount once again—just like a typical revolving line of credit.

This being said, however, compared to actual lines of credit, business credit cards will not offer as high of limits. Nevertheless, credit cards will have a fairly simple application process and are a great, flexible option for financing smaller, everyday business purchases. Plus, most business credit cards offer a rewards program that lets you earn points, miles, or cash back as you spend.

Depending on the credit card, you may need sufficient personal credit to qualify, but issuers will likely be less concerned with your time in business and annual revenue, as long as you have substantial personal finances. In this way, business credit cards are one of the best financial products for startups and new businesses. They also can be a great resource to use for smaller expenses if you’re using a term-loan or SBA loan to fund larger purchases.

Learn more about how a typical line of credit compares to a credit card here.

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Secured vs. Unsecured Revolving Lines of Credit

Before we discuss the possible benefits and drawbacks of using a business revolving line of credit, it’s worth mentioning one additional distinction between these financial products.

A revolving line of credit may be either secured or unsecured. With a secured business line of credit(also known as an “asset-based” line of credit) a creditor will require collateral or will place a lien on your assets as a condition of extending the credit. Therefore, if you default on your payments, the creditor can recoup their losses by seizing and selling the assets. An unsecured credit line isn’t backed by any assets or collateral.

This being said, however, an unsecured line of credit may still require that you sign a personal guarantee or agree to a blanket UCC lien, as a way for the lender to minimize their risk, even if you’re not providing a specific piece of collateral. Interest rates may also be higher on unsecured lines of credit compared to those that are secured by collateral.

Generally, there are three types of secured revolving lines of credit (described below)—and these are more often required by banks than by online lenders. Typically, online lenders will instead secure a line of credit with a blanket lien or personal guarantee.

    Equipment-Backed

    Just as auto loans allow borrowers to access capital collateralized by the vehicle itself, this revolving line of credit allows you to access a credit limit that’s secured by a piece—or pieces—of your business’s equipment and fixtures. If you can’t pay back what you borrow from this secured line of credit, the creditor will seize the equipment to recoup your unpaid balance.

    Inventory-Backed

    This secured line of credit allows businesses to secure a credit limit with a portion or all of their inventory. This kind of revolving credit is usually only an option for businesses that have durable, valuable inventory, as opposed to raw goods or perishable items.

    Invoice-Backed

    Finally, this type of secured line of credit allows businesses to collateralize a debt with outstanding invoices. You’ll access an advance of a portion of your accounts receivable, with a certain percentage held in reserve. Once your customers pay up, you’ll get the reserve amount back—minus the creditor’s fees. This funding process is also called invoice financing.

Pros and Cons of a Business Revolving Line of Credit

Now that we’ve explained what a revolving line of credit is, how it works, and the different types that are available to business owners, let’s break down the top benefits and drawbacks of this financing product.

How do you know if a revolving line of credit is right for your business?

Here are some points that can help you decide:

Pros of Revolving Lines of Credit

  • Flexibility: On the whole, revolving credit is a great option because of its flexibility. By getting a revolving line of credit, you’ll have access to fairly fast, affordable business funding that you can use as you need it. You can draw on your line of credit at any time and use the funds for a variety of purposes.
  • Repeated use: Additionally, revolving lines of credit offer financing that you can use repeatedly, as long as your revolving credit agreement is in effect. You won’t have to go through the process of applying for another financing product and will be able to borrow money and repay up to your credit limit over and over again. It’s important to keep in mind, however, that if you fall behind on payments then your lender might restrict your right to draw on the funds.
  • Less interest: Moreover, one of the top benefits of a revolving line of credit is that you’re only charged interest on the amount you draw—not the entire line of credit itself. Therefore, with this product, you have access to funds when you need them, but you only pay interest on the money that you actively invest in your business. This is a notable advantage over a traditional business term loan product, where you have to pay interest on the entire lump sum.

Considering these benefits, a line of credit is an ideal financial solution for:

  • Emergency situations
  • Seasonality cash flow issues and irregular revenues
  • Unexpected opportunities or purchases

Cons of Revolving Lines of Credit

Despite these advantages, there are also downsides that you’ll want to consider with regards to business revolving lines of credit:

  • Withdrawal requirements: Although one of the benefits of a revolving line of credit is that you can use it when you need it, certain lenders may have withdrawal requirements. This caveat will require you to withdraw a certain minimum amount of money within a particular timeframe, to guarantee that the lender can make some profit from the line of credit.
    The amount of a minimum draw varies, but some lenders require a 10% minimum draw. For instance, if you receive a revolving line of credit of $100,000, you would be required to withdraw at least $10,000, typically within the first three to six months of opening the account.
    If you plan to use the funds pretty frequently, this might not be an issue. However, if you were planning to get a business line of credit and save it for emergencies, you’ll want to make sure the lender you work with does not implement a minimum draw requirement.
  • Fees: Some lenders charge inactivity fees, where you’re charged a fee if you don’t use your revolving line of credit for a certain amount of time (usually one year). Additionally, some lenders charge withdrawal fees, where you incur a fee every time you withdraw money from your account. Typically these fees range from 1% to 3% of the amount you withdraw. Withdrawal fees incentivize borrowers to take out larger amounts of money at once (to avoid multiple fees), which also translates to higher interest.
  • Lower amounts of capital: Finally, you’ll want to keep in mind that compared to traditional term loans or other financing products, a revolving line of credit won’t give you access to as much funding. With many loans, you can borrow up to $5 million, or more. With a revolving line of credit, on the other hand, the maximum amount you can receive is usually around $300,000, especially if you’re seeking an unsecured business line of credit.
  • Higher interest rates: Plus, compared to other financing solutions, you’ll often find that lines of credit have higher interest rates, especially for short-term lines. Because lines of credit give you access to fast, flexible funding that can be used when you need it, the interest rates are often more expensive. This being said, secured lines of credit from banks or credit unions may be able to offer higher amounts and lower interest rates, but they’ll also be much more difficult to qualify for.

How to Get a Revolving Line of Credit

If you think a revolving line of credit is right for your business, you’ll likely want to know how to get one.

Ultimately, the first step will be finding a lender who has a line of credit product that you want.

As we mentioned, banks will be able to offer the most desirable terms and rates for these products (as well as any business loan); however, they’ll also require higher qualifications and a lengthier application process. There are also many online, alternative lenders on the market that can provide business revolving lines of credit with more lenient requirements and a simpler, faster application.

Once you’ve found the right lender for your business, you’ll have to actually complete the application. Here are the four main factors lenders will consider, so you’ll want to keep these in mind before you start the process:

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    Your Personal Credit Score

    As for any small business loan application, you’ll need to prove that you’re a reliable borrower in order to qualify for revolving credit. Especially for newer businesses, your personal credit history will be a strong indicator of how you’ll manage your business’s financials. 

    Therefore, you’ll want to check your personal credit ahead of time, considering various scoring models. If your score is within the 620 to 700 range, you should be able to qualify for a line of credit. If your credit score is higher than 700, you might even be able to work with a bank and score a lower interest rate.

    However, if your credit isn’t quite to the place where you can qualify for a revolving line of credit, you’ll want to keep on top of personal loan and credit card payments and decrease your credit utilization ratio to improve your credit score.

    If you need to access financing for your business now, though, you may look into business credit cards for building credit that can help you improve your personal credit and build business credit.

    Your Time in Business

    If your business has been around for a few years, this is an indication that you can withstand the test of time—and you might qualify for larger, less expensive revolving credit.

    If you’ve only been in business for a few months (less than six months, typically) you might have to meet other, higher standards to qualify.

    Your Annual Revenue

    It’s important that the lender gets a sense of your annual revenue. In most cases, they’ll determine your credit limit based on how much you bring in each year.

    Annual revenue is also a general qualification requirement. Ideally, you should have at least $25,000 in annual sales revenue to qualify for a business revolving line of credit.

    Your Average Bank Balance

    The funds you have in the bank help lenders gauge your cash flow and business profitability, as well as your preparedness for the unexpected.

    A potential creditor might request a balance sheet or an income statement from your accounting software to achieve the same end.

The Bottom Line

At the end of the day, a business revolving line of credit is one of the most flexible types of financing that small business owners can access.

Therefore, if you can qualify for a revolving line of credit (and aren’t charged non-use fees or face withdrawal limits) this is a great type of financing to have in your back pocket in case of emergencies.

This being said, however, there are limitations to lines of credit and they won’t be the right financing product for every situation or every business.

Ultimately, only you can determine if a revolving line of credit is the financing your business needs—and now that you have a better sense of how revolving credit works, you’re in the best place possible to make that decision. Plus, if you eventually decide a line of credit isn’t right for your business, you’ll still have a variety of types of business loans to consider and compare.

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Senior Contributing Writer at Fundera

Priyanka Prakash, JD

Priyanka Prakash is a senior contributing writer at Fundera, specializing in small business finance, credit, law, and insurance. She has a law degree from the University of Washington and a bachelor's degree from U.C. Berkeley in communications and political science. Priyanka's work has been featured in Inc., Fast Company, CNBC, and other top publications. Prior to joining Fundera, Priyanka was managing editor at a small business resource site and in-house counsel at a Y Combinator tech startup. Email: priyanka@fundera.com.
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