A revolving line of credit is basically an agreement between an individual or an entity and a bank or other financial institutions to borrow short-term money for a maximum fixed amount that is renewed when the balance is paid off or paid down. The bank will initiate a commitment fee the borrower must pay when opening the credit line.
When a borrower draws on a line of credit, interest expenses are charged. If charges are carried forward from month to month, then carry-forward charges are incurred as well. Revolving lines of credit are similar to personal credit cards, but they usually require some sort of collateral.
For individuals, this collateral may be an existing home or personal property. A home equity loan, aka HELOC, is an example of a personal revolving line of credit. The issuing agency uses your home as security provided you have a sufficient amount of equity in it, to grant you the credit line. If you default on your revolving credit, the house can be used as collateral to recover the value of the HELOC.
For businesses, revolving lines of credit are granted by creditors with inventory or accounts receivable used as collateral a majority of the time. If a company defaults on the revolving line of credit, the value of the loan can be recovered through the value of the inventory or accounts receivable.
Why Do Revolving Lines Of Credit Exist
Most of the time a person or company seeks a revolving line of credit need it to make up for shortfalls in revenue on a monthly basis. They may have Accounts Receivable outstanding or an influx of inventory. A revolving line of credit is a great way to add stability to any business that experiences a normal amount of financial fluctuation or is experiencing periods of growth that requires increased funding. Some take out credit cards to increase their credit score, for the points and rewards or to supplement their income. (see this article about How Many Credit Cards Should I have)
For individuals, revolving lines of credit such as home equity loans are a great way to consolidate debt at a lower interest rate than their current credit card companies are providing, or for making needed home improvements to maintain or increase the market value of a home. Homeowners often don’t realize the amount of money needed to keep a home in good condition and market ready. A HELOC is one way to mitigate this problem, given the right real estate market is in place.
Advantages Of A Revolving Line Of Credit
The nice thing about these types of loans is once you’ve been approved you never have to reapply. You won’t have to make payments until you actually draw money from the line, and you can repay it and reborrow it over and over again for usually up to about ten years with the option to renew. Personal lines of credit most often fall between $5,000 and $200,000 for average consumers.
For individuals seeking HELOCs, the amount you’ll be able to borrow will depend heavily on the value of your home, your credit rating, and the credit rating of any co-borrowers. If you have an established credit rating that is ranked well, you may be able to borrow up to 85% of the appraisal value of your home minus how much you owe on the property. Just be careful to read the terms of the loan, as many can have larger payments later in the loan repayment cycle, which can catch you by surprise.
Unsecured Lines Of Credit
There are also unsecured revolving lines of credit, similar to credit cards. These types of loans do not require collateral such as a piece of home property in a HELOC or an amount of inventory in a business line of credit. Credit cards are considered as unsecured revolving lines of credit.
With unsecured lines of credit, limits are typically a lot lower than secured versions, and the interest rate is considerably higher. This is because lenders are incurring more risk with unsecured revolving lines, so the money they make must be more secure.
The fees and costs involved in obtaining a revolving line of credit vary significantly from lender to lender depending on the specific line of credit you’re looking to open. You’ll be charged a regular interest rate that will range depending on your credit score and whether or not your revolving line of credit is secured or unsecured.
Some interest rates fluctuate depending on the prime rate. If you obtain a credit line with an APR of prime plus 2 points, the amount of interest you pay will vary with how much the prime rate varies. Make sure your loan has a cap on how high of an APR you have to pay to protect you from potentially soaring APRs.
For home equity loans, in particular, the fees incurred can be numerous. You’ll most likely need to pay an application fee of between $75 and $300. You may also have to pay to have your home appraised, which can cost anywhere between $150 and $450. You may have to pay points depending on your credit score, each one of which is worth one percent of the credit limit of the credit line. Finally, you may incur closing costs fees similar to those you paid when purchasing your home, which may vary between $75 and $350.
Some plans also charge transaction fees each time you make a withdrawal, or an annual maintenance fee to maintain the line of credit. While not every revolving line of credit has all of these fees, most contain at least a few. Make sure you take the time to read over all of the fees and terms involved in a revolving line of credit and don’t be afraid to shop around. Be aware of all the fees, and make sure you’re only borrowing what you need so you won’t be tempted by additional funds that you really don’t require.
The best way to use revolving lines of credit is to help your business or the value of your home grow. Using a revolving line of credit to reinvest in your business or your personal ventures will help to increase the value of these entities and increase your financial security in the long run.