Revolving Credit Definition
Revolving credit, also known as a line of credit, is a line of credit where the customers can access the money until they have borrowed up to the maximum limit set by an agreement. After paying back all or some portion of the outstanding balance (and any applicable interest), the borrower can again borrow against the account.
A Little More on What is Revolving Lines of Credit
In this line of credit, the customer pays a commitment fee to a lending institution for borrowing money. The amount is not fixed, and it depends on the need of the borrower. There is an upper limit, also known as the credit limit.
Both corporations and individuals can take out this line of credit. With businesses, the funds are generally used for operational purposes. Along with the commitment fee, the corporate borrowers need to pay interest on the money borrowed. Some borrowers are required to pay carry-forward charges if interest is not paid.
Financial institutions (typically banks or credit unions) enter into an agreement with customers after reviewing their financial records. These lenders judge the paying ability of the borrowers by reviewing their credit score, monthly income, and employment status. For corporate borrowers, the balance sheet, income statement. and cash flow records are reviewed.
The interest rates on revolving credit lines are generally higher than on similar installment loans. Revolving credit is the best for fluctuating cash flows and unexpected expenses. The main advantage of this type of credit over the traditional installment loan is its flexibility.
Home equity lines of credit and personal lines of credit are two of the most common examples of revolving credit.
Revolving credit is for a shorter period of time and generally for smaller amount than fixed sum, installment loans. The primary convenience is based upon the borrower being pre-approved. The borrowers do not have to go through a lengthy phase of paper work to borrow the money. They only have to pay the interest and any other applicable fees. The financial institution need more structured loan terms for a long-term loan for a larger amount.
Business credit cards and revolving credit are similar but different. With a credit card, a there must be a transaction of some sort. With revolving credit, no such purchase or transaction is required. The amount is directly transferred to the account of the customer. Also, no physical cards are involved in revolving credit. It’s more like a cash advance. Also, the interest rate on revolving credit is generally lower than the credit cards’ interest rate.
References for Revolving Credit
Academic Research on Revolving Credit
The determinants of contract terms in bank revolving credit agreements, Dennis, S., Nandy, D., & Sharpe, L. G. (2000). Journal of financial and quantitative analysis, 35(1), 87-110. This paper investigates the determinants of contract terms on bank revolving credit agreements of large and medium publicly traded companies. It illustrates how various single equation studies of contract terms draw the wrong conclusions because they incorrectly assume that other contract terms and leverage were exogenous. The results echo the hypothesis that the setting of the contract term is significant in reducing the contracting problems.
An analysis of revolving credit agreements, Hawkins, G. D. (1982). Journal of Financial Economics, 10(1), 59-81. This article investigates the pricing of intermediate-term line commitments which are mostly known as revolving credit agreements. It also derives two valuation models for infinitely-lived line commitments and which are based on the use of borrowing. The results show that the pattern borrowing of the firm primarily depends on the relative size of the fixed and variable costs of the line.
Revolving credit card holders: Who are they and how can they be identified?, Hamilton, R., & Khan, M. (2001). Service Industries Journal, 21(3), 37-48. This study focuses on identifying the characteristics of active cardholders with the highest propensity to revolve and uses two quantitative techniques that accompany credit risk management or credit scoring. The main result suggests that the most essential discriminating variables come from the card holder’s behavior. This result comes from the two techniques used for analysis.
Subsidies in the use of revolving credit, Dunkelberg, W. C., & Smiley, R. H. (1975). Journal of Money, Credit and Banking, 7(4), 469-490. This paper focuses on the measurement of subsidies in the use of consumer retail involving credit under the current local and institutional arrangements. It uses data from several surveys to compute the estimates of credit costs and revenues based on twelve-month account histories for every member of a sample of credit user.
Consumer revolving credit and debt over the life cycle and business cycle, Fulford, S., & Schuh, S. (2015). This article examines the changing credit availability, debt and utilization over the business cycle using data from the Federal Reserve Bank of New York Consumer Credit Panel (CCP), which contain a 5% sample of every credit account in the United States from 1999 to 2014 from the credit reporting agency known as Equifax.
Determination of an optimal revolving credit agreement, Berger, P. D., & Harper, W. K. (1973). Journal of Financial and Quantitative Analysis, 8(3), 491-497. This paper provides a solution to the problem of determining the optimal limits of available funds that a company is expected to maintain under a revolving credit agreement. These are formal or informal agreements made by many large companies with banks to cover the anticipated temporary cash needs and to provide assurance of the availability of funds against unanticipated cash requirements.
An alternative approach to ending economic insecurity in Nigeria: the role of revolving credit association, Ibrahim, S. S. (2012). International Journal of Economics and Financial Issues, 2(4), 395-400. This paper explains that since sustainable development is not feasible when a significant portion of the labor force is paralyzed economically. It also shows the implementation of numerous policies aimed at augmenting the disadvantaged population and creating a way for them to be able to seize the market opportunities. This method has worked in several places such as Ghana and is also expected to work in Nigeria.
Monetary and relative scorecards to assess profits in consumer revolving credit, Barrios, L. J. S., Andreeva, G., & Ansell, J. (2014). Journal of the Operational Research Society, 65(3), 443-453. This study presents a relative profit measure for scoring purposes and then compares these results with those gotten from monetary scores. The measure is the cumulative profit relative to the outstanding debt. The results indicate that the specific segments of customers are profitable in monetary and relative terms.
Revolving Credit and Credit Cards, Buerger, A. A. (1968). Law and Contemporary Problems, 33(4), 707-717. This paper focuses on the treatment of revolving credit in the Uniform Consumer Credit Code (UCCC) and then comments on the background and the workability of the solutions to the challenges that the code would accomplish. The paper also considers the federal Consumer Credit Protection Act of 1968 (CCPA) which is set to apply in states that the UCCC has not been enacted or where it differs from its original promulgation form.
Determinants of credit card debt: Differentiating between revolving credit debt and petty installment loan in China, Wang, L., Malhotra, N. K., & Lu, W. (2014). Journal of Consumer Behaviour, 13(4), 294-302. This study examines the determinants of the probability of having credit debt and those of the severity of credit card debt. It analyzes the behavioral data derived from a Chinese commercial bank, and it indicates a significant difference between the determinants of the possibility of having credit card debt and to the determinants of the severity of credit card debt.
Antecedents of consumer financing decisions: a mental accounting model of revolving credit usage, Perry, V. G. (2001). ACR North American Advances. This paper investigates whether mental accounting variables are significant predictors of revolving credit use and consumer price consciousness. The paper creates a multiple-item scale to measure mental budgeting and also utilizes a structural equation modeling approach to test the hypotheses. The results indicate that mental budgeting and short-term orientation accompany higher revolving credit use.
The impact of usury ceilings on revolving credit, Villegas, D. J. (1987). Economics Letters, 23(3), 285-288. This research investigates the effects that usury ceilings have on the availability of revolving credit. It performs an empirical study that indicates creditors tend to react to lower usury ceilings on revolving credit through decreasing the availability of revolving credit to the borrowers associated with high risk.