Revolving Credit: What You Need to Know as a Small Business
When it comes to borrowing for your business, understanding the types of credit available to you is key to knowing which type to use in different financial situations. The two main types of credit are revolving credit and installment credit.
If you’re seeking a financial cushion for emergencies, or foresee a situation where your business will need to borrow money repeatedly in the near future, a revolving account from your bank may be what you need.
In this article, we go through how a revolving line of credit works and whether it is the right choice for your business.
What is Revolving Credit?
Revolving credit is a type of credit that does not have a fixed number of payments or withdrawals. It gives you access to a set amount of money, usually determined by your lender, that you can access until you’ve borrowed up the maximum amount.
The borrower is free to use as much or as little of the line of credit as they wish, and the balance is “revolved” over to the next payment period if it is not paid off in that cycle. A classic example of revolving credit is a credit card.
Other common revolving credit examples are:
- Personal lines of credit
- Business lines of credit
- Home Equity Lines of Credit (HELOCs)
The revolving credit definition encompasses most lines of credit, a useful tool that many business owners are familiar with.
How Revolving Credit Works
When a lender gives your business a line of credit, it means that you have a set credit limit. You can access any amount of money up to that limit. It allows you to keep drawing from and repaying as often as you need. Your account balance is the total amount borrowed and is reduced by any payments you make to the account.
For example, if your limit is $2,000, you can borrow and repay any amount below that. If you’ve borrowed $500, your account balance on your line of credit is $500.
Interest is charged on the outstanding balance, which in this case would be a percentage of the $500 you’ve used. This interest is carried over from month to month, depending on your revolving credit accounts terms. There may also be other fees charged, such as annual fees, origination fees, and penalties for missed or late payments.
You can choose to pay your account balance plus fees in full at the end of each billing cycle or carry over a balance to the next. To revolve the balance, you will be required to make a minimum payment for each cycle.
How Revolving Credit Impacts Your Credit Score
Having a revolving credit line can improve your credit score as a business, but on the other hand, it can also negatively impact it.
- Payments History
Your loan payments history has the biggest effect on your score. Consistently making your required payments on time greatly improves your credit scores and overall credit health.
Good payment history can also help you negotiate a more favorable interest rate on your account. However, missing payments can have a big and lasting impact on your score.
- Utilization Rate
This is the total current balance divided by the total of your credit limits. Heavy reliance on the credit extended to you is a red flag to lenders as it could signify negative business cash flow. Experts advise maintaining a rate below 30%, even with revolving credit card debt.
- Hard Enquiries
When you apply for revolving credit, your lender will request your file from credit bureaus. This results in a hard inquiry which usually lowers your credit score by a few points, though only for a short period.
Is Revolving Credit Good?
Revolving credit is beneficial in several ways:
- If you have limited experience with credit, a revolving credit line like a credit card can help diversify your accounts.
- Revolving credit can give much-needed relief to business owners for financial emergencies.
- Since interest is charged only on the account balance, it can be more affordable than other types of credit.
- Paying off your credit reliably builds your credit history.
- “Revolve limit credit cards” often come with rewards and money-back offers which can help your business save if used correctly.
Tips to Best Manage Revolving Credit
Like all business loans, careful management can make the difference between whether the credit is beneficial or detrimental to your business. Revolving credit management tips include:
- Make sure to pay your minimums on time to avoid interests and late penalties. Additionally, paying more than the minimum can help to improve your credit score.
- Keep your account balance low. Maxing out your credit line negatively impacts your credit score, in addition to paying a higher interest.
- Monitor your spending. Having a high credit limit can be tempting and encourages unnecessary purchases.
- Avoid too many applications over a short period. Plan ahead to help you space out drawing from your credit line.
If this article answers your questions around revolving accounts and they seem like a good option for your business, L3 Funding’s merchant funding options are a good place to start.
We make it super quick and simple for businesses to apply. Contact us if you would like to learn more.
