When your small business needs additional capital, it’s not uncommon to turn to a lender to quickly get the funding you need to operate or expand your business. Fortunately, there are many funding options available to small businesses, from low-interest Small Business Administration loans to lines of credit.
For small business owners that want a flexible form of financing, a line of credit is a popular option. When applying for a line of credit, you’ll encounter two options: revolving lines of credit and non-revolving lines of credit. In this post, we’re going to explore the differences between the two. Which option is best for your business? Read on to find out!
What Is A Revolving Line Of Credit?
A revolving line of credit is also known as open-ended credit. A lender provides you with a set credit limit, similar to a credit card. You can make draws on this line of credit as many times as you wish, provided you don’t exceed your credit limit.
Once you’ve made a draw, you’ll begin to repay the borrowed funds, plus interest and/or fees, on a schedule set by the lender. Repayments are typically made once per month or weekly, although this varies by lender. As you pay down your balance, the funds are replenished and become available to use again and again, giving you easy, on-demand access to the capital you need when you need it.
A revolving line of credit can work for any business. However, businesses that have a recurring need for capital will benefit the most from this type of funding. Businesses in the foodservice or retail industry, for example, would benefit from a revolving line of credit because funds could be used to purchase inventory or supplies as needed.
Let’s take a look at an example. A business has been given a line of credit up to $20,000. The business makes a draw of $2,000 from the line of credit. The business pays back $1,000 of the line of credit. At this point, up to $19,000 is available to borrow. The business makes draws of $5,000. Now, the line of credit is at $14,000. Over the next few months, the business repays $2,000. The business still owes the lender $4,000 (plus interest and/or fees) and has $16,000 available to draw.
What Is A Non-Revolving Line Of Credit?
A non-revolving line of credit is similar to its revolving counterpart in a few ways. Instead of receiving a lump sum of cash as you would with a traditional loan, a non-revolving line of credit gives you access to a credit limit assigned by the lender. You can make one or multiple draws on your line of credit provided you don’t exceed your credit limit.
A non-revolving account does not replenish after you pay your balance. When the funds are depleted, the account is closed. If additional funds are needed, you would have to apply for a new line of credit or other financial product.
Let’s take a look at an example. Let’s say that you have a non-revolving line of credit with a limit set at $20,000. You draw $5,000. Your balance is now $15,000. Even though you repay the $5,000 (plus interest and/or fees), your balance remains $15,000. You draw another $10,000, bringing your balance down to $5,000. After making multiple payments, your balance remains $5,000. Once you’ve drawn the remaining balance, the lender will close your line of credit.
A non-revolving line of credit is still quite flexible, Your funds will be available to use as you need them, and you can make as few or as many draws as you need until you hit your credit limit. Any business can benefit from a non-revolving line of credit. However, these funds can be used for a variety of purposes, including hiring and training new staff, purchasing additional inventory during a busy season, or using to fill in revenue gaps.
Revolving Line Of Credit VS Non-Revolving Line Of Credit
While revolving and non-revolving lines of credit are very similar in a lot of ways, there are a few distinct differences between the two. Understanding these differences can help you make the best choice for your business.
Revolving and non-revolving lines of credit both allow you to make multiple draws as needed up to your assigned credit limit. However, the primary difference is what happens once your credit limit is reached. For revolving lines, funds are replenished as you pay off borrowed funds. Non-revolving lines do not replenish their funds, and the lender will close the account once the credit limit has been reached.
Maintaining Your Account
In most cases, a revolving line of credit will remain open provided you pay off borrowed funds as agreed. You will not have to submit multiple applications to maintain your account. However, the lender may periodically check your credit or the performance of your business to determine if changes need to be made to your account.
If you receive a non-revolving line of credit, your account will be closed once all of the funds have been used. At this time, you can fill out another application to receive another line of credit. However, if your situation has changed (i.e., your credit score has dropped or your revenues are lower), you may not qualify for the same credit limit, terms, and interest rates as you did before, so this is something to keep in mind.
Typically, non-revolving lines of credit have lower interest rates than revolving lines of credit. However, you should still shop around. Other factors including personal and business credit profiles, annual revenues, and available collateral can also have an impact on your interest rate.
Maximum Borrowing Amount
If you’re looking to borrow a larger amount of money, you might want to consider applying for a non-revolving line of credit. Non-revolving lines of credit aren’t as risky as revolving lines, so lenders often are willing to offer higher borrowing limits to qualified borrowers. Maximum borrowing limits vary by lender — as well as factors including credit score and business performance — so, again, make sure to explore your options before committing to a lender.
Which Is Right For Your Business?
Still scratching your head deciding which line of credit is best for your business? To help you make the right decision, take these factors into consideration.
As previously mentioned, non-revolving lines of credit pose less risk to lenders, so initial credit limits are often higher. If you need access to a higher amount of capital, consider applying for a non-revolving line of credit or even a traditional small business loan.
Use Of Funds
If you need consistent access to cash for purchases like inventory or supplies, a revolving line of credit that replenishes over and over again will be a better fit for your business. If your capital needs are more occasional, a non-revolving line may be the best choice.
You also need to evaluate the borrowing requirements of each line of credit you’re considering. The lines of credit with the lowest interest rates and best terms typically require a longer time in business, a good-to-excellent credit score, and higher revenues. If you have past credit challenges, there are lenders that offer lines of credit based on the performance of your business. Be aware, however, that these lenders often have higher interest rates and/or fees that raise the total cost of borrowing.
Time To Funding
You also need to consider how quickly you need access to cash. There are many revolving lines of credit available that you can access within just minutes of submitting your application. On the flip side, getting a non-revolving line of credit from your bank or credit union may take longer, but you could receive much better rates and terms.
Your revolving or non-revolving line of credit may be secured or unsecured. If the line of credit is unsecured, a specific asset is used to back the loan. This is typically business assets, such as equipment or real estate. If you don’t make your payments as agreed, the lender has the right to seize the property to repay the debt.
If your line of credit is unsecured, it isn’t tied to a specific asset. However, you may still have to sign a personal guarantee or the lender may put a blanket lien on business assets.
Interest rates are typically lower and maximum borrowing limits are typically higher on secured lines of credit. Both revolving and non-revolving lines of credit can be secured or unsecured, so make sure to understand collateral requirements when applying for your line of credit.
Where To Find Revolving & Non-Revolving Credit
With an understanding of revolving and non-revolving lines of credit, you should have an idea of whether or not this is the right funding option for your business. If so, the next step is to find your lender. There are multiple sources available that offer lines of credit to businesses just like yours.
Many banks offer lines of credit to small business owners. Lines of credit from banks often have the lowest interest rates, minimal fees, and best repayment terms. The downside is that banks typically have the strictest borrowing requirements, so this option is best for established businesses. To get started, visit your current financial institution, or shop around your options at local banks in your area.
If you’re a new business owner or don’t meet the requirements for a business line of credit, you may be able to apply for a personal line of credit provided you meet the lender’s requirements.
Like banks, many credit unions offer business and personal lines of credit with competitive interest rates. While borrower requirements may not be quite as strict as banks, all borrowers should have a solid credit profile, steady revenue, and meet other criteria set by the lending institution. To apply for a line of credit or other financial product, you must be a member of the credit union.
The internet has made it easier than ever to get the funding you need by connecting you with a network of alternative lenders around the nation from the comfort of your home or office. Many alternative lenders offer prequalification tools that allow you to see if you’re eligible for funding without taking a hit to your credit score. Alternative lenders may have applications that are fast and easy, allowing you access to funds within minutes of hitting “Submit.”
One of the positive aspects of working with an alternative lender is that most don’t have the strict requirements found with traditional lenders. In some cases, the performance of your business is what qualifies you for funding, so personal credit challenges, a lack of business credit, or even a short time in business doesn’t bar you from approval. On the downside, though, you’ll find that interest rates are higher, additional fees must be paid, and terms aren’t as favorable as those that come from banks and credit unions.
A line of credit can be a great way to boost cash flow for your business. However, it’s important that you shop around, understand the cost of borrowing, and ensure that a line of credit is the best option for your specific situation. If you decide that a line of credit is a good fit for your business, check out our list of the best lenders that offer lines of credit. If this funding doesn’t seem like the best fit, consider other financial products such as SBA loans, small business loans, or business credit cards.
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