What is Revolver Debt?
Revolver debt, also known as revolving debt, is a form of credit that can be accessed by corporations and individuals. What separates revolving debt from regular installment loans, then? In a regular loan, the borrower is given access to a fixed sum of money that must then be amortized and paid off over the loan term. For example, a borrower may have been lent $100,000 by a bank to start a business. The term of the loan is two years, and the borrower is required to pay the $100,000 plus interest back over this period.
In revolver debt, the borrower is instead given a line of credit with a maximum limit. The borrower can access any amount up to this limit at any time and does not have a specific term to pay the loan back. However, interest will accrue on any outstanding funds borrowed. For example, a borrower is given a revolving line of credit with a maximum limit of $100,000 by a bank to start a business. The borrower can take out $0, $1,000 or $95,000 tomorrow, depending on his or her needs.
Difference between Revolver Debt and Installment Loans
- In revolver debt, the borrower can re-access any funds that have been paid back. In installment loans, once the loan has been repaid, the borrower must reapply for a second loan if he or she wishes to borrow more.
- In revolver debt, there may not be a fixed payment value or term. In installment loans, the interest and principal payments are fixed.
- Revolver debt will usually come with higher interest rates than installment loans, due to the greater uncertainty with repayments.
Common Types of Revolver Debt
- Personal lines of credit: An individual can apply for a personal line of credit, also known as an LOC. These lines of credit will come with a maximum limit and interest rate that is based on several factors, such as the borrowers’ credit score and credit history.
- Home equity lines of credit: These LOCs are also known as HELOCs, and have most of the features of a personal line of credit. However, HELOCs are only accessible to homeowners. They are backed by the equity of the homeownership, and thus usually come with a lower interest rate than a standard LOC. HELOCs may or may not be affected by characteristics of the owner’s mortgage.
- Credit cards: A credit card is a common form of revolver debt. The credit limit is the maximum limit. Once funds have been paid off, the borrower will have access to credit once more up to the maximum limit. Typically, credit cards have the higher interest rates amongst HELOCs and LOCs.
- Revolving credit facility: A revolving credit facility works for corporations much in the same way as personal LOCs do for individuals. A firm may have a revolving credit facility with their bank that allows them to access credit funds when needed.
Common Uses of Revolver Debt
- Revolver debt is useful for individuals or corporations that have uneven cash flows or need emergency funds due to the possibility of unexpected expenses.
- Revolver debt is also useful for entrepreneurs, contractors, self-employed individuals and professionals who work on commission. Because their income is uncertain and irregular, access to revolver debt can smooth out cash flows between paychecks.
- In a corporate setting, having access to a revolving credit facility helps corporations with working capital management. This access will allow easier funding for day-to-day operations.
- Finally, personal lines of credits can be used to lower the interest payments on credit cards. This can be done by transferring any outstanding balance on a credit card to a personal LOC, as the former usually incur higher interest rates.
Revolver Debt in the Context of Financial Modeling
Because revolving debt is not linear and predictable like regular loans, it is much harder to prepare a debt schedule. Transitively, it is also harder to predict future uses of revolving debt needed for forecasting. This requires subjective reasoning and logic on the part of the financial analyst. A useful step is to check historical trends to see if the company has any policy on their revolver debt. If this is unavailable, the financial analyst may elect to zero-out future forecasts of revolver debt, or set it at a constant value with recurring interest payments.
To learn more about debt funding and credit issues, see the following resources.
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