What is the difference between a revolving credit facility and a term loan?

While a revolving credit facility is a type of loan, there are some key differences that set it apart from a regular term loan. Credit cards that allow you to take out money, pay it back, and take it out again are known as revolving credit lines. Term loans typically require borrowers to take out a single sum of money and agree to pay a fixed sum of money back over a set period of time.

A variety of loan products are available for you to consider. They can be secured or unsecured, with fixed or variable interest rates, depending on the type of loan. Loans can have a wide range of features, but some may be similar while others may be completely different. Both revolving and fixed-term loans come with a variety of advantages and disadvantages. In order to make the most of the financing facility, both individuals and businesses must be aware of the key differences between both types of loans

Revolving Credit Facility (RFS)

It’s a contract that allows an account holder to borrow money up to a certain amount while repaying a percentage of the current balance in monthly installments. Each payment refills the account holder’s available funds, minus the interest and fees incurred. Your monthly payments are flexible with a revolving facility because the lender sets the maximum amount that can be borrowed and repaid each month. After you’ve withdrawn the money, you’ll be obligated to pay it back according to the terms of your agreement.

How it works

A credit limit on an RC account is the maximum amount you can spend on that account. You have the option of paying off your balance in full at the conclusion of each billing cycle, carrying a balance over to the following month, or “revolving” the balance. You must make a minimum payment each month when you revolve a debt. Some businesses pay their employees’ salaries via revolving credit. Not all of the time, but when they require more cash to get their firm back on its feet.

Features of an RCF

• Cash Sweep

A cash sweep provision is frequently included in the revolver’s design. It indicates that the bank will utilize any surplus free cash flow created by a firm to pay down the revolver’s existing loan ahead of schedule. Instead of dispersing the cash to its shareholders or investors, this compels the firm to repay the debt at a quicker pace.

• Interest Expense

The borrower is only charged interest on the amount withdrawn, not on the whole loan line. The revolver’s remaining half is constantly ready to fire. The revolver’s major benefit comes from this characteristic of built-in versatility and ease.

• Maximum Amount

When a company’s cash flow is insufficient to satisfy its financial commitments, it might draw from a revolver to make up the difference. The bank has established a maximum borrowing amount. The bank may, however, evaluate the revolver on an annual basis. If a company’s sales drop dramatically, the bank may reduce the revolver’s maximum amount to safeguard it from default.

• Commitment Fee

A bank may impose a commitment fee to start the revolving credit facility. It rewards the lender for maintaining open access to a possible loan, with interest payments starting only when the revolver is drawn on.

• Reusability

Easy repayment and re-use are two advantages of revolving loans. A revolver loan is so named because once the outstanding balance is paid off, the borrower can utilize it again and again. It’s a rotating cycle of withdrawing, spending, and repaying until the arrangement expires, or the revolver’s term expires.

Term Loan

The term loan refers to a form of credit vehicle in which a sum of money is given to another party in exchange for the value or principal amount being repaid in the future. A term loan is a broad term encompassing different types of products, the most prominent term loan products are unsecured or secured loans. This type of loan is known as “term” because it’s only available for a predetermined period of time (the term).

• Small Business Loans

A funding option applicable to businesses with a turnover below £6.5m and fewer than 50 employees, small business loans are ideal for giving a boost to young businesses who want to enjoy low interest rates and flexibility in how the borrowed money can be used. Less importance is placed on credit rating and trading history during the application phase, as the business’ youth is considered. Suitable for businesses looking to take advantage of an exciting opportunity or wanting a quick stopgap of working capital.

• Secured Business Loan

A secured loan is, as the name suggests, a loan that is secured to a particular asset within your business. This could be equipment, machinery, vehicles, or perhaps property. When you take out a secured loan you are placing that particular thing down as a safety net. This means that should you not make the payments as and when you need to, then the lender can take away that asset.

A secured loan is seen as a much lower risk than an unsecured loan, which means that you will often get a better rate than that of an unsecured loan. You are also much more likely to be able to secure this type of loan if you have a bad credit history.

• Unsecured Business Loan

Similar benefits and application process to small business loans, but without restrictions on age or turnover. Precedence is instead given to the credit rating of the applicant’s business, with preference given to those with a solid financial history. Unsecured Business Loans are suitable for businesses looking for cash to grow and develop, but who do not want to part with equity.

Term loans provide the stability of fixed repayments and a predetermined repayment schedule. Fixed and variable interest rates are available for both types of loans. Term loans are better suited for long-term fixed asset investments while revolving loans are better suited for short-term working capital needs.

Get in contact with a member of the team at Funding Bay to find out more about revolving credit facilities and term loans, and to find out what product is best suited to your business and its needs. Funding Bay is here to assist you at all times.

Why Understanding Loan Types is Important 

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1. Strategic Financial Planning
2. Risk Management and Mitigation
3. Enhancing Operational Efficiency
4. Long-Term Financial Health

Strategic Financial Planning

• Informed Decision-Making:Knowing the options available ensures that the funds are used efficiently, minimising costs and maximising benefits.
• Optimising Cash Flow: Understanding the nuances of different loans aids in maintaining healthy cash flow, which is vital for daily operations and growth.

Risk Management and Mitigation

• Minimising Financial Risks: Each loan type carries different levels of risk. Term loans with fixed interest rates can protect against market volatility, whereas RCFs allow businesses to draw funds as needed, reducing the risk of over-borrowing. 
• Building Creditworthiness: Regular and responsible use of RCFs can demonstrate creditworthiness, potentially leading to better loan terms in the future. Similarly, successfully managing term loans can improve a business’s financial standing.

Enhancing Operational Efficiency

• Tailored Financial Solutions: An RCF might be ideal for handling unexpected expenses or seasonal fluctuations, while a term loan might be better for financing major capital expenditures. Selecting the appropriate loan type ensures that the business remains agile and responsive to changing circumstances.
• Supporting Growth and Expansion: RCFs provide the flexibility needed for short-term expansions or operational adjustments, whereas term loans offer the capital necessary for significant investments like new facilities or equipment.

Long-Term Financial Health

• Sustainable Debt Management: Effective use of loan products contributes to sustainable debt management. By balancing short-term needs with long-term financial planning, businesses can avoid over-leveraging and maintain a healthy debt-to-equity ratio.
• Achieving Strategic Goals: Ultimately, a deep understanding of different loan types enables businesses to align their financing with their strategic goals. Whether it’s stabilising cash flow, funding growth, or mitigating risk, selecting the right loan type is a key component of achieving business objectives.

Key Considerations When Choosing Between an RCF and a Term Loan

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Purpose of the Loan

Short-term Needs

• Seasonal Cash Flow Management: Revolving credit facilities (RCFs) are ideal for businesses that experience seasonal cash flow fluctuations. For example, a retail business might use an RCF to manage inventory purchases before the holiday season and repay the credit once sales peak.
• Handling Unexpected Expenses: RCFs provide a safety net for unexpected costs such as emergency repairs or sudden increases in operating expenses. The ability to draw funds as needed and repay them flexibly makes RCFs suitable for managing these short-term financial challenges.

Long-term Investments

• Purchasing Equipment: Term loans are better suited for financing significant, long-term investments such as purchasing machinery, vehicles, or other essential equipment. The fixed repayment schedule helps businesses plan their finances more effectively over the long term.
• Expanding Business Operations: For projects like opening a new branch, renovating existing facilities, or investing in major infrastructure, term loans provide the necessary capital with a clear repayment plan, making them ideal for long-term growth initiatives.

Loan Structure and Flexibility

Credit Utilisation

• Revolving Credit: One of the primary benefits of an RCF is its flexibility in borrowing and repayment. Businesses can draw from the credit line up to a specified limit, repay what they owe, and borrow again as needed. This revolving nature ensures continuous access to funds, which is especially useful for managing variable expenses.
• Term Loans: In contrast, term loans involve borrowing a lump sum that must be repaid over a fixed period. This structure is less flexible but provides stability and predictability in repayment, making it suitable for planned expenditures and long-term projects.

Repayment Adjustments

• Flexible Repayment Schedules with RCFs: RCFs offer the advantage of flexible repayment schedules. Businesses can make minimum payments or pay off the balance in full, depending on their financial situation at the time. This flexibility helps manage cash flow more effectively and adjust to changing financial circumstances.
• Fixed Repayment Schedules with Term Loans: Term loans typically come with fixed repayment schedules, meaning businesses must make regular payments over the loan term. While this lack of flexibility might seem restrictive, it also provides certainty, helping businesses budget and plan their finances with a clear understanding of their future obligations.

Try Our Business Loan Calculator

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Whenever you’re pursuing a loan for your company, use our Business Loan Calculator to compare terms and agreements to find the most suitable option for your needs.