Revolving Line of Credit
Definition
A revolving line of credit is a type of credit facility provided by a financial institution that allows the borrower to withdraw, repay, and redraw money up to a pre-approved credit limit on an ongoing basis. Unlike a traditional loan, which is disbursed in a lump sum with fixed payments, a revolving line of credit offers flexibility in terms of the amount borrowed and repaid.
Examples
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Personal Revolving Line of Credit: An individual may use a revolving line of credit for discretionary or emergency expenses. For instance, a homeowner might use their home equity line of credit (HELOC) for renovations or unexpected repairs.
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Business Revolving Line of Credit: A business might utilize a revolving line of credit for working capital to manage cash flow, pay for operational costs, or handle short-term financial needs. For example, a retailer might draw on their credit line to purchase additional inventory before a peak sales period.
Frequently Asked Questions
Q: What distinguishes a revolving line of credit from a term loan?
A: A term loan provides a lump sum that is repaid over a set period with fixed payments, while a revolving line of credit allows for continual borrowing and repayment up to a specified limit, offering more flexibility.
Q: How are the interest rates on revolving credit lines typically structured?
A: Interest rates on revolving credit lines are usually variable and can change with the prime rate or another benchmark rate. Some lines of credit may offer an introductory rate or allow for the negotiation of fixed rates.
Q: Can my revolving line of credit limit be increased?
A: Yes, borrowers can often request an increase in their credit limit, although approval depends on creditworthiness and the lender’s policies.
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Revolving Credit: A broader term encompassing any credit arrangement that facilitates repeated borrowing up to a certain limit with no fixed number of payments.
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Credit Limit: The maximum amount that can be borrowed on a revolving line of credit.
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Home Equity Line of Credit (HELOC): A revolving line of credit secured by the equity in a borrower’s home.
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Variable Interest Rate: An interest rate on a loan or line of credit that changes over time based on an index or benchmark.
Online References
Suggested Books for Further Studies
- Lines of Credit: Rethinking the Value of Credit in Developing Economies by Lydia J. D. Leynes
- The Handbook of Credit Management by Burt Edwards
- Principles of Bank Lending by Richard E. Cascarino
Fundamentals of Revolving Line of Credit: Business Finance Basics Quiz
### How does a revolving line of credit differ from a traditional term loan?
- [x] A revolving line of credit allows continual borrowing up to a limit, whereas a term loan provides a lump sum.
- [ ] A term loan has a variable interest rate, while a revolving line of credit has a fixed rate.
- [ ] A revolving line of credit is only available to businesses.
- [ ] A term loan does not require credit approval.
> **Explanation:** A revolving line of credit allows for repeated borrowing and repayment up to a specified credit limit, unlike a term loan, which involves a lump sum disbursement and fixed repayment schedule.
### What is a common use for a business revolving line of credit?
- [ ] Paying long-term debts
- [ ] Financing real estate purchases
- [x] Managing short-term cash flow needs
- [ ] Buying office furniture
> **Explanation:** Businesses often use revolving lines of credit to manage short-term cash flow needs, ensuring they can cover operational costs and unexpected expenses.
### Can the credit limit of a revolving line of credit be increased?
- [x] Yes, subject to lender approval and borrower’s creditworthiness
- [ ] No, it is fixed for the term of the account
- [ ] Yes, but only once per year
- [ ] No, it decreases over time
> **Explanation:** The credit limit on a revolving line of credit can typically be increased upon request, based on the borrower’s credit profile and lender’s policies.
### What type of interest rate do most revolving lines of credit have?
- [ ] Fixed interest rate
- [x] Variable interest rate
- [ ] Zero percent interest rate
- [ ] Introductory interest rate only
> **Explanation:** Most revolving lines of credit have variable interest rates that adjust over time based on an index or benchmark.
### What is a Home Equity Line of Credit (HELOC)?
- [ ] A revolving line of credit for businesses
- [x] A revolving line of credit secured by a homeowner's property equity
- [ ] A term loan used for home improvements
- [ ] A personal loan for credit repairs
> **Explanation:** A HELOC is a type of revolving line of credit secured by the equity in a homeowner’s property, allowing them to borrow as needed.
### Who can apply for a personal revolving line of credit?
- [x] Any individual who meets the lender's credit criteria
- [ ] Only individuals with a home mortgage
- [ ] Business owners only
- [ ] Only individuals with no existing debt
> **Explanation:** Any individual who meets the lender's credit criteria can apply for a personal revolving line of credit, regardless of other financial obligations.
### How is interest on a revolving line of credit typically calculated?
- [ ] On the total credit limit
- [ ] On the unused portion of the credit line
- [x] On the portion of the credit line that is drawn upon
- [ ] Based on annual income
> **Explanation:** Interest on a revolving line of credit is usually calculated on the amount borrowed or drawn upon, not the entire credit limit.
### What security may be required for a revolving line of credit?
- [x] Collateral, such as property or receivables
- [ ] No security or collateral is required
- [ ] Only the borrower’s signature
- [ ] Fixed deposit account
> **Explanation:** Many revolving lines of credit, especially for businesses, may require collateral such as inventory, property, or accounts receivable.
### What is a minimum payment on a revolving line of credit?
- [x] The smallest amount that must be paid to avoid penalties
- [ ] The full payment of the outstanding balance
- [ ] The annual interest amount
- [ ] The opening fee for the credit line
> **Explanation:** The minimum payment is the required amount the borrower must pay to avoid penalties, typically including interest and a portion of the principal.
### What factor is crucial for accessing a higher credit limit on a revolving line of credit?
- [ ] Having multiple credit cards
- [x] Maintaining a good credit score
- [ ] Frequent use of the credit line
- [ ] High-income level
> **Explanation:** A good credit score is crucial for accessing a higher credit limit, as it demonstrates creditworthiness and responsible borrowing behavior.
Thank you for exploring revolving lines of credit with us and challenging yourself with our quiz questions. Strive to deepen your financial knowledge for better financial management!
