Understanding Revolving vs Term Credit Facilities

Quick overview

Revolving and term credit facilities are foundational loan structures for businesses. Revolving facilities provide reusable access to capital (like a business credit card or line of credit). Term facilities deliver a one-time lump sum repaid in installments over a fixed period. Selecting the right structure influences working capital, interest expense, covenant design, and financial flexibility.

This article explains the operational mechanics, pricing and fee differences, typical use cases, underwriting considerations, real-world examples, conversion options, and practical steps to choose between them.

How each facility works — mechanics and lifecycle

• Revolving credit facility

• Structure: Lender sets a committed credit limit (for example, $500,000) and an availability period (commonly 12 months or longer). The borrower may draw, repay, and draw again up to that limit during the availability period.

• Repayment: Minimum payments usually cover interest on outstanding amounts; some facilities require periodic principal amortization or seasonal paydowns.

• Fees: Common fees include an unused-commitment (or facility) fee on the undrawn portion, a drawing fee, and an interest rate spread over a benchmark (now typically SOFR in U.S. markets) (ARRC/Federal Reserve guidance).

• Renewal and termination: At maturity lenders may renew the commitment, reduce the limit, or terminate the facility after a review. Revolvers are often used as a liquidity backstop.

• Term credit facility (term loan)

• Structure: Borrower receives a fixed principal upfront (e.g., $2,000,000). The loan has a fixed maturity and a predetermined amortization schedule (monthly, quarterly, or annually).

• Repayment: Principal and interest are repaid according to the schedule; some term loans include interest-only periods or balloon payments at maturity.

• Fees: Origination fees, prepayment protections (step-down breakage fees), and customary loan-documentation costs.

• Lifecycle: Once repaid, the principal is gone; you cannot redraw without negotiating a new loan or conversion.

Pricing and benchmark notes

• Benchmarks: Since the LIBOR phase-out, most U.S. dollar commercial lending references SOFR (Secured Overnight Financing Rate). Lenders price facilities as a spread over SOFR or over a bank’s internal base rate. See the ARRC and Federal Reserve guidance for the SOFR transition.
• Cost comparison: Revolving facilities often have higher effective cost when you include unused-commitment fees and higher spreads on unsecured lines. Term loans, especially secured or amortizing ones, can offer lower spreads because lenders see them as lower credit risk over the life of the loan.
• Total cost considerations: Compare all components — interest on drawn balances, facility fees, arrangement fees, legal costs, covenant compliance costs, and prepayment penalties.

When to use each — practical use cases

• Use a revolving credit facility when:

• You need short-term working capital and variable borrowing (seasonal inventory, payroll gaps, receivables timing).

• You want a committed backup for contingencies or to support a credit rating covenant.

• You anticipate frequent draws and paydowns and need the convenience of re-borrowing.

• Use a term credit facility when:

• Funding a capital expenditure (equipment, real estate acquisition) where a fixed amortization matches the useful life of the asset.

• Financing a defined project or expansion with predictable cash flows.

• You want predictable principal and interest schedules for budgeting.

Underwriting, covenants, and collateral

• Underwriting: Lenders assess cash flow coverage, leverage ratios (EBITDA-based), historical financials, industry risk, and owner equity. Startups without operating history may find it easier to obtain smaller revolving lines or asset-backed facilities than unsecured term loans.
• Covenants: Revolvers commonly include liquidity and borrowing-base covenants (e.g., accounts-receivable availability), while term loans often emphasize leverage and interest-coverage covenants. Both can include negative covenants restricting dividends or additional indebtedness.
• Collateral: Both facility types may be secured. Typical collateral: accounts receivable, inventory, equipment, or real estate. Unsecured facilities exist but carry higher interest rates and stricter covenants.

Real-world examples and outcomes

1) Seasonal retailer (revolver): A regional apparel retailer draws $300,000 during inventory buildup before the holiday season, reduces the balance post-season, and re-borrows the next year. The revolver provides low-cost liquidity when needed without repeated loan closings.

2) Manufacturer investing in plant expansion (term loan): A manufacturer borrows $1.5 million on a 7-year amortizing term loan to buy new presses. The predictable payment schedule matches the machines’ depreciation and allows the business to forecast cash needs precisely.

3) Hybrid approach: Companies commonly combine both: a term loan to acquire fixed assets and a revolving credit facility to cover seasonal working capital. That structure optimizes financing cost while preserving operational flexibility.

In my practice working with small and mid-sized firms, the hybrid structure is the most common recommendation — it lowers long-term cost and keeps short-term liquidity available for volatility.

Conversion and refinancing options

• Converting revolver to term loan: Lenders sometimes allow you to convert an outstanding revolver balance into a term loan to lock in amortization and reduce interest expense. This is common during covenant renewals or when borrowers seek predictable amortization.
• Refinancing term loans: Borrowers may refinance to secure lower spreads, change amortization, or consolidate debt. Prepayment fees and breakage costs often apply; negotiate these into the credit agreement if possible.

Common mistakes and negotiation tips

• Mistake: Treating a revolver as permanent equity. A revolver is debt and may be recalled; don’t rely on it for irreversible capital projects without a backup plan.
• Mistake: Ignoring unused-commitment fees when comparing offers. Two offers with similar margins can have very different economics once fees are included.
• Negotiation tips:
• Ask for an initial covenant-lite period (90–180 days) after closing if your business has a transition quarter.
• Negotiate cap on unused-commitment fees or a step-down as balances grow.
• Seek flexibility on excess cash sweeps — for term loans this can materially affect liquidity.

A short checklist to evaluate offers

• Is the facility secured or unsecured?
• What is the pricing formula (spread over SOFR or base rate)?
• Are there unused-commitment or arrangement fees?
• What covenants trigger default or acceleration?
• Is there a material adverse change (MAC) or “springing” covenant?
• Can the revolver be converted to a term loan, and if so, on what terms?

Regulatory and consumer-facing considerations

For consumer products (HELOCs, business lines that touch consumer credit), the Consumer Financial Protection Bureau (CFPB) provides rules and disclosure expectations; small-business borrowers should watch for disclosures and abusive terms (consumerfinance.gov). For tax treatment of interest costs, consult IRS guidance or a tax advisor; interest deductibility may vary by use and by tax years (IRS.gov).

Internal resources and further reading

• Read our primer on Revolving Credit to understand how lines of credit affect credit utilization and credit reports.
• See our Term Loan glossary page for examples of amortization schedules and term-loan covenants.
• For business borrowers considering short-term options, our Business Line of Credit page explains borrowing bases and seasonal structures.

Practical example with numbers

Scenario: Company A has a $500,000 revolver (spread = SOFR + 275 bps; unused-commitment fee = 0.50% annually) and considers taking a $500,000 5-year term loan (spread = SOFR + 225 bps; origination fee = 1%). If SOFR averages 1.50% during Year 1, the revolver effective drawn rate is ~4.25% on used balances, plus the unused fee on undrawn amounts. The term loan’s nominal rate is ~3.75% plus a one-time 1% fee. Over a 5-year horizon with steady principal reduction, the term loan often has lower total cost for fully amortizing purposes; the revolver is cheaper only if the company repays quickly and avoids significant unused-commitment fees.

(These numbers are illustrative — always run the cash-flow math on actual lender offers.)

Final recommendations

• Use a revolver when your primary need is variable working capital or a committed contingency backstop. Expect some ongoing fees but gain flexibility.
• Use a term loan when financing fixed assets or long-term investments where predictable amortization supports planning and may reduce total interest expense.
• Consider a combined structure for many growing businesses: term financing for fixed assets plus a smaller revolver for working capital.
• Always model scenarios including fees, covenants, and prepayment costs before choosing.

Professional disclaimer

This article is educational and does not constitute legal, tax, or investment advice. In my practice advising small and mid-sized businesses, I recommend reviewing term sheets with your legal counsel and tax advisor before accepting financing. For regulatory guidance and consumer disclosures, consult the Consumer Financial Protection Bureau (consumerfinance.gov) and for tax questions, consult IRS guidance (irs.gov).

Authoritative sources and further reading

• Consumer Financial Protection Bureau — consumerfinance.gov (line-of-credit and disclosure guidance).
• Small Business Administration — sba.gov (loan programs and lender considerations).
• ARRC / Federal Reserve materials on the SOFR transition and benchmark references.