A Line of Credit (LOC) is a type of financing arrangement available to businesses and individuals. It has various characteristics and features that provide users with benefits. When it comes to choosing a line of credit facility, there are two prevalent options from which users must choose. These are the revolving and committed lines of credit. There are some differences between them.
What is a Revolving Line of Credit?
Through a revolving line of credit, lenders assign a specific credit limit for borrowers. They evaluate various factors before deciding on them. These factors include the borrower’s credit score, history, and income. Once a borrower obtains a revolving line of credit, they can use or reuse the account based on their requirements.
A revolving line of credit account closes when the lender or borrower decides to terminate it. Until its closure, the facility stays open for transactions up to the predetermined credit limit. Borrowers usually avail a revolving line of credit to fund their operational needs. It allows them to take out variable amounts of credit each month, depending on their cash flow needs.
Companies that obtain a revolving line of credit may use collateral to secure the deal. By doing so, they can receive a higher credit limit and better repayment terms. Some lenders may also link the limit to their specific assets, such as inventory. The lender can sell the secured asset to recover the debt if the borrower defaults.
With a revolving line of credit, the borrower gets more flexibility. However, they must also bear higher interest rates and an unpredictable repayment schedule. Similarly, the credit limit set in this type of line of credit is lower than other types. All these issues come due to the higher risk involved for the lender with a revolving line of credit.
What is a Committed Line of Credit?
A committed line of credit is a facility that lenders cannot suspend without notifying the buyer. It is a legal agreement that outlines the conditions of the line of credit between both parties. Once both parties sign the agreement, the loan provider will lend money to the borrower. However, the borrower must abide by the conditions set in their agreement.
Unlike uncommitted lines of credit, the lender cannot suspend the loan. The agreement specifies the times or maturity date for the repayment of funds by the borrower. The contract may also include any fees that the borrower has to bear for unused portions of the facility. However, these fees are usually minimal.
Unlike a revolving line of credit, a committed line of credit may not be suitable for operating needs. Borrowers use a committed line of credit as a safety net against anticipated expenses. Similarly, for companies, it may help address sudden declines in revenues or profits. Some companies may also use it for unanticipated costs or expenses.
Having a committed line of credit facility can be beneficial for companies. It can also be useful when companies are going through liquidity or cash flow problems. They can also use it to assure shareholders that it can continue its operations when taking on new projects. However, the usage for this facility is usually short-term rather than long.
A line of credit is a credit facility available to individuals or businesses. A revolving line of credit allows borrowers to repay or reuse the funds available up to a specified limit. On the other hand, a committed line of credit is a facility that the lender cannot terminate. Both can have their specific use cases for companies.