It is a type of financial loan from a bank or financial institute with flexible payment and withdrawal terms. Both individuals and businesses can avail themselves of the revolving credit facility, but it’s more popular with businesses.
The bank or the lender issues the credit facility against collateral and agreed terms like another debt facility. However, revolving credit differs in characteristics from fixed loans.
- The borrower can withdraw any amount of cash within the granted credit facility limit; it doesn’t require further approvals for each withdrawal.
- The bank charges interest only on the portion of the loan withdrawn, and for the time period, the borrower uses that amount.
- The borrower may not opt to withdraw at all, or deposit the partial amount again to reduce the interest charges
- The credit facility is payable in full at the maturity date
- The interest charged by the lenders is variable and can change with the market interest rates. i.e. from the federal bank interest rates.
For individuals, a credit card is one basic form of a revolving credit facility. The banks charge interest on the amount utilized and the customers can withdraw up to a certain limit. Home equity line of credit (HELOC) is another form of revolving credit facility for individuals that come with variable interest rates.
Businesses avail of the revolving credit facility to meet their working capital requirements. As often their accounts receivables are delayed, and they face short-term cash crunches. Once the business receives from its customers, they can top-up the revolving credit immediately to save on interest charges.
Unlike credit cards, the revolving credit facilities for businesses are dealt with through bank accounts, and they do not charge for cash withdrawals. These facilities help businesses in running their operating expenses, as uncertain economic conditions make it difficult to receive payments quickly.
Fixed Loans V Revolving Loans:
For individuals, the comparison may basically involve their creditworthiness. Individuals usually prefer fixed-term loans as their sources of income are usually predictable and fixed in the foreseeable future.
Fluctuating interest rates rise over the years, so it makes an expensive choice for individuals to opt for revolving credit facilities. Individuals opt for revolving credit facilities usually applying for refinancing or second mortgages in the form of HELOCs.
Businesses look for immediate liquidity solutions. If their accounts receivable and working capital requirements are met through operating income, they would prefer fixed-term loans.
However, uncertain market conditions and customers relations compel businesses to prolong their account receivable days. Businesses can save on the interest charges while they receive cash gradually from operating income. It offers a flexible short-term liquidity solution for businesses. The interest charged on revolving credit loans is usually higher than the fixed term loans.
The interest rates with revolving credits are also variable. If the business cannot offer collateral, they may still avail the facility for the short-term depending on their relations with the banks.
Banks and other financial institutes offering revolving facilities carry out the same due diligence procedures as with any other loans. They have the choice of setting up the upper limit cap for the credit facility. The interest rates also vary with the federal government announced rates and market conditions, so it makes an attractive investment for banks too.
Considerations for Borrowers:
Although the revolving credit facility offers great flexibility for the borrowers, they must also realize the repercussion attached to it. For example, under economic recession times, federal governments usually lower interest rates.
Revolving credit facilities such as a Home line of Credit (HELOC) may look an attractive option to individuals in the short-term, but the interest rates are bound to rise once the recession is over.
Similarly, for corporate borrowers, they must introspect to their ability to repay the credit facility in full. Interest payments are usually smaller and can be reduced with the partial repayments.
The credit facility must be repaid in full once the maturity date arrives. The business must carefully plan for that balloon large payment. Also, for individuals and corporate borrowers, utilizing the credit facility to the maximum can damage their credit score.
The credit facility utilization directly affects the credit utilization ratio, which is an important metric for the credit score calculation.
In conclusion, the revolving credit facility is more suited to corporate borrowers. It offers them a short-term liquidity solution with partial repayment and withdrawal options. Variable interest rates and credit utilization are the main concerns for both individual and corporate borrowers with a revolving credit facility.