A personal credit card is an example of a revolving line of credit. But can a business use this type of financing as well? Without involving an actual credit card? Many successful businesses find that such financing is exactly what they need.
The greatest benefit to a revolving line of credit (RLOC) is that it may be used repeatedly as long as borrowed funds do not exceed a pre-approved credit limit. This limit will be set by the lender based on the borrower's credit worthiness and repayment history, as well as the profitably and cash flow of the business. Monthly payments by the borrower are based on the amount of credit that has been used, with interest applied to make it profitable for the lender. There is generally a minimum payment but there are no prepayment penalties. So the borrower is free to repay the loan in one lump sum or over time, adjusting the repayment amount to changing needs.
Another benefit is that this type of financing allows a new business to establish a credit history fairly quickly. That may result in more attractive corporate credit offers from the lender, especially if the borrower keeps the account in good standing.
What are the drawbacks to this type of financing? There is usually an upfront fee to get the revolving line of credit going. But most types of loans contain some sort of processing fee or another, so this isn't unusual. The pre-approved credit limit cannot be exceeded by a borrower. In an emergency, this could be problematic. But a consultation with the lender, along with the borrower's stellar repayment history, may allow the limit to be raised.
Another fee that may creep in is an unused funds fee. When first opening the line of credit, the bank places the full loan amount into an account that is pledged to the borrower. If the credit line has not been used for a specified period of time, the lender may impose a fee as a way to profit from those set-aside funds. After all, the lender is in the lending business to make money. This fee may be negotiable, however, so it is important to discuss it with the lender upfront. Late payment fees may come into play as well. A borrower should get all fees described in writing before taking out a revolving line of credit.
This type of loan is usually secured by the accounts receivable or the inventory of the business. Failure to repay the loan could result in confiscation of either. Without A/R, a business will have little income. Without inventory, a business will have nothing to offer its customers. This could result in a business being pushed rapidly out of operation.
Another drawback is that these types of loans may incur higher finance charges than traditional loans. Similar to personal credit cards, they assess interest at an annual periodic rate that is broken down by month. Over time, the borrower may not pay attention to the larger rate, focusing instead on the smaller monthly portion. In doing so, he may lose track of how much he is actually paying in interest on the loan-and how much interest is being added to the principal balance. Again, the interest rate assigned will depend upon the borrower's or the business's financial records and history.
A new business owner should keep in mind that any type of loan will have benefits and drawbacks. A little research and guidance from the lender will determine the correct type of loan for their company.
Corporate Credit Concepts specializes in Revolving Line of Credit. For more information about Revolving Line of Credit and how it might benefit your business, please CLICK HERE for a free phone consultation.