A revolving loan is a line of credit that allows the borrower to access a certain amount of money, pay it back, and access it again when needed. This type of loan is most often used to finance large or long-term purchases. The borrower has the ability to withdraw funds up to the maximum loan limit and make payments on the loan until the balance is paid off.
Example of Revolving loan
A revolving loan is an agreement between a borrower and a lender that allows the borrower to access a certain amount of money, pay it back, and access it again when needed. This type of loan is typically used to finance large purchases such as a car, home, furniture, or education. The borrower will be given a credit limit to access funds up to the maximum loan limit and can make payments on the loan until the balance is paid off.
Benefits of a revolving loan include convenience, flexibility, and a lower interest rate than other loans. Disadvantages include the temptation to use the funds for unnecessary purchases, difficulty tracking payments and the loan balance, and potential consequences from late payments or defaulting.
Formula of Revolving loan
The formula for calculating the total amount of a revolving loan is:
Total Amount = (Interest Rate x Balance) + (Principal x Number of Payments)
- Interest Rate = annual percentage rate (APR)
- Balance = the amount of money borrowed
- Principal = the amount of money borrowed
- Number of Payments = the total number of payments to be made over the course of the loan.
When to use Revolving loan
- Revolving loan is most useful when you need funds for large purchases which you can repay over a long period of time. The lower interest rate makes it an attractive option for those who want to save money over the long term.
- This type of loan is also great for businesses that need to access funds for seasonal expenses or investments. The flexible repayment terms allow businesses to use the funds when needed and make payments when it is convenient for them.
- Revolving loans are also useful for those with fluctuating income, such as freelancers or entrepreneurs, who may need funds to cover their expenses until they receive their next payment.
Types of Revolving loan
- Personal Line of Credit: A personal line of credit is a loan that allows borrowers to access funds up to a certain limit and make payments on the loan until the balance is paid off. It is typically used for large purchases such as home improvements or to cover medical expenses. This type of loan often has a lower interest rate than other types of loans.
- Credit Card: A credit card is a type of revolving loan that allows the user to borrow up to a certain limit and make payments on the loan until the balance is paid off. Credit cards typically have higher interest rates than other types of loans, so it is important to pay off the balance as quickly as possible.
- Home Equity Line of Credit: A home equity line of credit is a loan secured by the borrower’s home. This type of loan allows the borrower to access funds up to a certain limit and make payments on the loan until the balance is paid off. Home equity lines of credit typically have lower interest rates than other types of loans, making them a good option for borrowers who need large amounts of money.
Advantages of Revolving loan
- Convenience: A revolving loan provides borrowers with the convenience of being able to access funds as they need them.
- Flexibility: This type of loan is typically more flexible than other types of loans and allows borrowers to make payments as they can.
- Lower interest rate: Revolving loans usually have a lower interest rate than other types of loans.
- Increased access to funds: Borrowers may be able to access additional funds if their credit score improves over time.
Limitations of Revolving loan
- High Interest Rates: Revolving loans usually carry a higher interest rate than most other types of loans. This can make them expensive to use, especially if the borrower does not pay off the loan quickly.
- Credit Score: The borrower's credit score plays a major role in determining the interest rate and loan limits. Those with a lower credit score may not be able to access a revolving loan or may get a loan with a higher interest rate.
- Fees: Revolving loans can also come with fees such as annual or origination fees. It is important for borrowers to be aware of the fees they may be charged when taking out a revolving loan.
- Debt Consolidation: Debt consolidation is a type of loan that allows borrowers to combine multiple debts into one loan with a single monthly payment. By consolidating multiple debts into one loan, borrowers may be able to reduce their overall monthly payments and interest rates.
- Refinancing: Refinancing is a process of taking out a new loan to pay off an existing one. This type of loan can help borrowers to reduce their overall interest rate and monthly payments. Refinancing can also be used to consolidate multiple debts into one loan.
- Home Equity Loans: Home equity loans are typically a type of loan that is secured by the equity in the borrower’s home. Home equity loans can offer borrowers lower interest rates and longer repayment terms than other types of loans.
In conclusion, revolving loans are an effective way of financing large or long-term purchases, offering borrowers convenience and flexibility. However, borrowers should carefully consider the terms of the loan and make sure they understand the potential risks and rewards before committing to a revolving loan. Additionally, borrowers should explore other loan options and consider the advantages and disadvantages of each to find the one that best suits their needs.
- O'Toole, L. J. (1996). Hollowing the infrastructure: Revolving loan programs and network dynamics in the American states. Journal of Public Administration Research and Theory, 6(2), 225-242.