Difference between Revolving Credit and Overdraft
While reading about credit cards, you might have come across the term revolving credit often. Today I will try to explain what revolving credit is and how it is different from overdraft facility.
Revolving Credit or Revolver
Think of a scenario wherein you are allowed to take a loan amounting to a specified sum from a bank in lieu of a commitment fee. But, you have an option to select the number of installment payment cycles as well as the installment amount in each of these cycles. Isn't it a dream come true for any debtor? I think yes. And this is exactly what revolving credit is. This loan can be withdrawn, repaid, redrawn any number of times until the contract ends. Sounds familiar. Yes, Credit cards are examples of revolving credit.
In this facility, banks determine the maximum limit of credit facility to be provided to an individual or corporation depending on their credit worthiness. Once this upper limit has been finalized, the bank enters a contract with the borrower, wherein the borrower agrees to pay off this loans and interest rates (if applicable) during the contract term. The borrower can withdraw loans any number of times and pay them off depending on his capabilities anytime. This repayment too can be partial or in full and depends on the borrower. The available credit is directly dependent on the amount of money borrowed and subsequently repaid. Small businesses use this facility from lending institutions for financing their capital expansion needs or to help them during rough financial periods.
Caution: Higher interest rates and penalty charges may be applied under some conditions.
In bank overdrafts you are given the facility by the bank to withdraw a sum over and above the
balance available in your account. In return of this withdrawal, the bank charges a fixed interest and you have to repay the amount due within a year. Above the interest, banks can charge you an annual overdraft fee as well. Having overdraft facility will ensure that the check issued by you doesn’t bounce as bank will take care of it. In other words we can say that bank overdraft is when the account balance becomes negative.
Revolving Credit vs Overdraft
In revolving credit, the biggest benefit one gets is that he can take a loan anytime, anywhere without going through the hassle of applying for it each time. You can use this facility for any purchase, small or big. But with all the benefits of “revolver”, you also have to take care of one of the biggest hazard of such type of lending – the terms of credit are never clear or fixed. You need to really dig into the terms and conditions section to ensure that you don’t get a rude shock later on. In case of overdraft, all the terms are pretty straight forward with respect to interest rates and annual fees agreed upon upfront with no unnecessary clauses.
Overdrafts are a far better and easy way to be in control of your expenses as against the temptations of revolving credit.
Bottom Line: Both revolving credit facility and overdraft facility are good for people to keep their finances in control. While organizations and small businesses prefer overdrafts, retail users go for revolving credit.
Before finalizing which one to get, read all the terms and conditions and seek help from your financial adviser.
Fun Fact: Revolving Credits are also known as ‘evergreen’ loans.
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