Understanding Revolving Credit vs. Non-Revolving Credit
If your small business needs extra cash for a project or new hire, you may be looking for a loan. Two terms you might encounter are: revolving and non-revolving credit.
It’s important to understand the difference between the two types of credit in order to identify which type of credit you may be qualified for, and which is best for your unique situation.
What is revolving credit?
Revolving credit is credit that your small business can keep using (or revolving) each month. It is very similar to using a personal credit card. You will receive a credit “line” and it will specify a maximum amount (your credit limit) that you can “draw” against the credit line that is extended to you.
You will accrue interest for any amount that you borrow. Depending on the type of revolving credit, you may owe at least a minimum payment each month on the debt — or you may be required to pay the balance in full each month. If you are allowed to carry a balance forward, that balance will continue to accrue interest until you pay it off. You are typically permitted to pay off the full balance any time that you want.
When you have a small business, revolving credit can be in the form of a business credit card or a business line of credit.
Using a business credit card is a form of revolving credit that can be a great way to manage expenses for your business. One major benefit is that business credit cards often earn lucrative rewards and points. Lenders will often limit how much credit you can get extended on a business credit card – it is uncommon to see a credit line higher than $50,000 to $100,000 of credit extended on a small business credit card.
In addition, interest rates on business credit cards can be quite high if you don’t pay off the balance in full every month. Another important thing to know is that business credit cards come with fewer consumer protections than you may be familiar with on your personal credit cards. For example, the bank could unexpectedly change your APR in an instant, or your late fees could be extremely high.
Business Line of Credit
An alternative to a business credit card is a revolving business line of credit. You will be able to draw money off this credit line. Business lines of credit are typically up to $100,000, although larger businesses may be able to get larger lines.
Unlike a business credit card, there is no “card” to speak of. It is most similar to a cash advance and it does not need to be tied to a specific transaction that your business is going to incur. You can typically get the money at any time for any reason, and use it for your business in however you see fit.
Note that lenders are typically entitled to “call” a line of credit whenever they want, which means they will demand that you pay back the loan immediately and won’t let you draw against it anymore. In some cases, lenders may change their lending priorities, or may fall on hard times and decide to stop lending to small businesses.
It can be hard to predict when lenders will pull credit lines, so it is a good idea to diversify your lending relationships across multiple lenders. Lenders may also reduce the amount of credit you can draw against whenever they want.
What is non-revolving credit?
Non-revolving credit is different from revolving credit because it doesn’t “revolve” from month to month. It is more similar to a traditional loan. Once you pay it off, you can’t draw it out again without applying for another loan. The types of loan you may be familiar with that are non-revolving credit are your home mortgage, student loan, personal loan, or car loan.
When your business decides to take out non-revolving credit, you and your loan broker will determine the amount you want to withdraw as well as the interest rate that is going to be charged. You will typically be on a fixed repayment schedule, although different loans can sometimes have different repayment terms. If you are on a fixed payment schedule, you will know how much you need to pay back each month.
Sometimes you are permitted to pay extra or pay off the entire balance early, but be aware that there can sometimes be prepayment penalties on small business loans. If you pay off your non-revolving loan, you will need to apply for another loan in order to take out additional funds.
Can interest on revolving and non-revolving loans be deducted on my business’s taxes?
Generally, yes. If the interest was paid on a loan that was used for business purposes, the interest is usually deductible. There are some requirements that you must fulfill.
What’s the difference between revolving and non-revolving credit?
There are a few key differences between revolving and non-revolving credit.
Interest Rate: Non-revolving credit often has a lower interest rate because it typically has collateral behind it. Since non-revolving credit has lower credit risk, you can typically get approved for a higher amount of funds with a non-revolving loan than a revolving loan.
Payment Schedule: Non-revolving credit usually has a fixed repayment schedule, so you will know how much you owe every month.
Mechanism of Charging Interest: Non-revolving credit will charge interest on the entire outstanding balance, which you receive as a lump sum at the beginning when you take out your loan. When you use revolving credit, you only pay interest on the amount that you draw out, which you can take over time and pay down as you wish. This way, you can better control the amount of interest being charged.
Prepayment Penalties: Some non-revolving credit lines charge you prepayment penalties if you pay off the loan early.
When should your business use a revolving credit line?
If you often need fast access to cash for your business, a revolving credit line may be a good fit, because once you have secured the line, you don’t need to apply for credit repeatedly in order to use it.
When should your business use a non-revolving credit line?
When you have a predictable project and need for funds, a non-revolving credit line may be the best fit. Non-revolving credit lines come with lower interest rates and predictable repayment schedules.