Understanding Interest Rates For Revolving Lines Of Credit
Like all other loans, revolving lines of credit have an interest rate, but the manner of calculating it is quite different from the others. Understanding how to determine the interest rates for revolving lines of credit is essential in managing your repayments and overall business expenses.
The Basis of Interest Rates
A traditional loan’s interest rates are either fixed or variable. That of a line of credit is floating, which is usually based on the prime rate. If you’re curious what it is, just check out the newspapers such as the Wall Street Journal. Because it’s floating, it can change periodically. Your interest expense, therefore, can differ each time you make a payment.
The Purpose of the Principal Balance
The basis of your interest expense depends on the principal balance, which is basically the amount you borrowed over a certain period. This is different from a traditional loan, where the principal is based on dividing the total amount over a certain period (like years). It is also unlike that of the credit card, where the remaining balance is rolled to the next pay cycle and charged another interest.
Number of Days
When you borrow an amount from your revolving credit, you are charged with an interest expense every day it remains unpaid. But don’t panic. To determine the actual interest per day, you multiply the balance with the prime rate. Multiply the product with the number of days in a month before you divide the product with 360 days (1 year).
How Does It Work?
With the above information in mind, how do interest rates for revolving lines of credit are determined? To understand, let’s have an example.
Let’s pretend you have a credit limit of $100,000 for your revolving credit. To increase your inventory for the beginning of the year, you borrowed $30,000 on January 2. You then paid off the entire amount on January 15, when the floating prime rate was 3%. To determine your interest, you multiply $30,000 with 3% (.03), which will give you $900. Now multiply that with the number of days until repayment, which is 14, you will have $12,600. Then divide this amount with 360 days, so you have $35 interest.
Here’s another example. Let’s assume on February 1, you borrowed $25,000 for payroll. If you’re planning to pay off your loan on February 16 and February 28, respectively, evenly, how much will be your total interest expense? Let’s pretend your floating prime rate for each of these days is 3% and 3.5%.
So from February 1 to 16, your interest expense is $16.67. Then from February 17 to 28, your interest expense is $14.58. Your total expense is roughly $31.25. You then add this amount to any fixed fee or charge plus the principal balance you need to settle within these dates.
Even if you have to pay interest rates for revolving lines of credit, they normally appear cheaper than with a traditional loan or even a credit card. Nevertheless, plan accordingly as prime rates can change quickly.
Don’t be intimidated by the numbers and interest rates for revolving lines of credit. Know the ins and outs of this excellent financial tool at www.revolvinglinesof.credit so you are properly guided.