Revolving credit: Overview, definition, and example
What is revolving credit?
Revolving credit is a type of credit arrangement that allows a borrower to access funds up to a certain limit, repay them, and then borrow again as needed. Unlike a traditional loan, which is paid off in fixed installments over time, revolving credit offers flexibility. The borrower can withdraw funds, repay them, and then access the credit again without needing to reapply, as long as they stay within the credit limit and make the necessary payments.
Common examples of revolving credit include credit cards and lines of credit. With revolving credit, borrowers are usually required to make minimum payments each month, and they can carry a balance from month to month, subject to interest charges on the outstanding balance.
Why is revolving credit important?
Revolving credit is important because it provides flexibility for borrowers to manage their finances by allowing access to credit whenever needed, up to a pre-approved limit. It can be a useful financial tool for businesses and individuals alike, offering a way to cover short-term expenses or manage cash flow more efficiently.
For businesses, revolving credit can be essential for maintaining liquidity, handling unexpected costs, or managing inventory. For individuals, credit cards are a common form of revolving credit, offering convenience for everyday purchases and emergency expenses while providing the option to carry a balance.
Understanding revolving credit through an example
Imagine a small business, ABC Store, that uses a revolving line of credit from a bank with a $50,000 limit. ABC Store can borrow funds up to this limit as needed, such as for purchasing inventory, covering payroll, or handling short-term operational costs. If the business borrows $30,000 to restock inventory, it can make monthly payments to reduce the balance. Once the balance is paid down, ABC Store can borrow again up to the $50,000 limit without needing to reapply for a new loan.
In another example, an individual, Sarah, has a credit card with a $5,000 limit. Sarah uses the card to make purchases and carries a balance of $2,000 from month to month. As long as she makes the minimum monthly payment, she can continue to use the credit card, and as she pays down the balance, she can borrow more if needed, up to the $5,000 limit.
An example of a revolving credit clause
Here’s how a revolving credit clause might appear in a loan agreement:
“The Borrower is granted access to a revolving line of credit in the amount of $100,000. The Borrower may borrow, repay, and reborrow up to the credit limit at any time, subject to the terms of this agreement. Payments will be due on a monthly basis, with a minimum payment of 5% of the outstanding balance or $500, whichever is greater. Interest will accrue on any outstanding balance at a rate of 12% per annum.”
Conclusion
Revolving credit is a flexible financial product that allows borrowers to access funds as needed, repay them, and borrow again, all within a specified credit limit. It offers convenience and can be a valuable tool for managing cash flow, covering unexpected costs, and maintaining financial flexibility.
For SMB owner-managers, understanding how revolving credit works and using it effectively can help maintain liquidity, support business growth, and manage day-to-day operational expenses while avoiding cash flow disruptions.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.