23.03.2023

OVERDRAFT, REVOLVING LOAN OR LINE OF CREDIT

The overdraft as well as the revolving credit are intended to provide revolving financing to the business. For both types of loans, a limit is approved up to which the borrower can use amounts. Both loans are short-term and are used within one year, after which they must be reviewed and the term extended.

In practice, the revolving credit has many of the characteristics of another type of credit - a line of credit. It represents the maximum amount of credit that a customer can withdraw within a certain period of time, and the borrower can repeatedly withdraw funds and repay them within the contract period.

What is an overdraft?

An overdraft is a credit limit on a current account, suitable for meeting short-term business needs. The amount of the overdraft is determined in relation to the bank turnover of the company. The used amount of the overdraft increases as payments are made from the company account to suppliers and decreases automatically as cash flows to the same account.

The main difference between an overdraft and a revolving credit comes from the need to request amounts to draw on the revolving credit. With the overdraft, amounts are withdrawn automatically, without the need to make a withdrawal request. The overdraft is granted as a limit on the account on which you receive your income. When amounts are received on this card account, the amounts used by the overdraft are automatically repaid.

You can have a revolving credit on another account, which will only be for the purpose of drawing and repaying the credit. Revolving credit works on the principle of a credit card - the bank sets a fixed credit limit for you, and you can not spend the entire amount, but only a part of it according to your needs. Each month, you pay installments that include the portion of the loan you used, as well as the interest on that portion.

If desired, the bank can issue you a bank card attached to the loan to facilitate you as much as possible. It's called a revolving credit card. Unlike other types of credit, where you withdraw a certain fixed amount, with the withdrawal of a revolving credit, you can use a very small part of the allocated funds and repay them quickly. This type of loan gives you more freedom.

Revolving credit fees vary by credit institution. In addition to the borrowed amount, your monthly payments also include the interest and fees due on the current obligation. For this reason, payments can often vary from month to month, as the calculations are based on how much of the credit limit you've used.

Pros and cons of revolving credit

A major plus of revolving credit is time savings for your business, as you don't need to apply constantly, and whenever you need money, you can use part of the credit.

Another convenience is the bank card, which provides constant access to the money that you can withdraw from an ATM, even when the bank is not working. With a revolving credit, the bank gives the user the opportunity to plan repayment without tying him to fixed monthly installments.

In addition to the positive sides, it also has negative sides. For example, the higher interest rate compared to traditional loans, the calculation of bank fees, late penalty interest and others make it not as attractive as it seems at first glance.

If you don't pay the minimum monthly payment on time, you may be subject to penalties. You should also keep in mind that revolving credit usually charges higher interest rates than consumer credit. Another downside is that even if you decide not to withdraw a penny from the loan, you will have to pay a commitment fee and other fees described in your contract.

In case of non-payment, the creditor has the right to block your account if you do not make your payments regularly or meet the minimum installments described in the contract. If this happens, you will no longer be able to use the money on the loan. What's more, you may have to pay penalty fees, even if they are not clearly mentioned in the contract. Some banks cleverly disguise them in the bank's "Terms and Conditions" section.

If you choose to pay only the monthly minimum, your interest rate can increase significantly. In such a case, it would be more profitable to focus on another loan than to remain on a revolving credit.

If the contract you sign with the bank or creditor does not have all possible details filled out, including the revolving period and the amount, you should not sign it. If you sign such a document, you can become a victim of an unscrupulous creditor and then not be able to prove your rights in court.

Features of the credit line

A line of credit is suitable for financing all current activities of your business, without the need to repeatedly apply for credit during the year. After limit approval, funds are disbursed by request from the client. The amount used from the line is repaid with a request submitted by the customer after his current account is funded.

With this type of credit, the creditor sets a limit for an amount that is permanently available to the recipient. The money from the credit line within the specified limit can be withdrawn and repaid at any time, with the debtor paying interest only on the used amount of the limit. After repayment of the utilized amount from the credit line under the terms of the contract, the person can apply for a new credit line.

A line of credit is a contractual agreement between a financial institution (most often a bank) and a borrower that specifies the amount of money (the limit) that the customer can withdraw. The bank may require the borrower to make minimum repayment installments when using a credit line.

The main difference with revolving credit is that a line of credit is a one-time arrangement and once it is paid off, the account is closed and can no longer be used. If you wish to open a new credit line, apply again.

In the case of the revolving or "open" line of credit, there is the possibility of re-granting the entire loan without drawing up a new contract.

Like most loans, revolving credit and lines of credit may be available with or without collateral. This largely depends on the desired credit limit and the conditions of the lending bank.

With both loans, users must have an open current account with the creditor bank. On this account, they receive and repay the loan funds, having a predetermined withdrawal limit. Interest rates are determined by the prime rate and are floating. They are repaid only on the used assets that the customer has already withdrawn from his working capital account.

The limit on the overdraft or credit line that the consumer can take advantage of depends on his monthly income and the degree of credit security. Some lenders have a requirement when applying for an overdraft that the entire amount of the monthly remuneration be transferred to the account. Often, the overdraft is granted for a short period of up to 12 months, but its extension is automatic and the credit line revolves (it is renewed after its repayment).

Although the credit line is most often used by businesses (business credit line) – companies and legal entities that regularly need liquid funds, it can also be used by individuals to cover various needs.