What is a credit facility?

This is one alternative for the self-employed or for small-medium businesses that must manage occasional needs for capital.

You can think of the credit facilities as the piggy bank that you have saved for emergencies or moments in which you need money urgently but not have it. In essence, credit facilities resemble loans granted by banks, although there are important differences that make them highly useful financing instruments for SMEs and self-employed workers.

Some further details on this type of financing: a credit facility is a loan granted by the bank, which offers capital so long as we need it. This is important, because contracting a credit facility does not mean that you must make use of all of the capital made available with it: you can use just the amount you consider necessary.

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Differences between a credit facility and a loan

Credit facilities open a line of financing between the customer and the bank. This allows you to always have a certain amount of money available, which you can make use occasionally whenever needed. This also means that when you contract a credit facility you do not receive the money being loaned right away, but instead you will have access to it anytime you need to use it.

In contrast, when a loan is granted the full amount of capital requested goes directly into your bank account. Regardless of whether we spend that money or not, we will have repay the capital in full, plus interest.

That is another key point worth highlighting, since when we use a credit facility we only pay interest on the money we actually use, not the total credit granted.

For example, let's imagine that we are going to take out a credit facility with a limit of €20,000. During the first few months we do not need to touch this money, but an emergency forces us to withdraw €5,000. When we come to return the money, we will only pay interest on the €5,000 that we withdrew, not on the full €20,000.

Commonly, credit facilities are for a one-year term, at the end of which the customer can choose to renew them or not.

When a credit facility may be useful

In the day-to-day activities of companies there are times when capital is needed but, for whatever reason, it is not available. This is where the credit facility comes into play, for example, in a case where one of your customers is delaying payment when you had already planned to use that money to pay your own company's expenses.

It is therefore a solution for those cash and working capital tensions that occur from time to time in any SME.

However, the use of the credit facility is not recommended for fixed or regular expenditure that we can plan for and assume in another way. You must remember that, in the end, the money made available to you is a loan, which brings with it interest and a series of other costs.

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Costs of a credit facility

The main costs of this form of financing come in the form of fees. The most typical ones are those listed below, although some banks may include these while others may not:

  • Commitment fee: this is a percentage of the total amount of credit requested, and it tends to remain at 2% or less.
  • Annual renewal fee: only applied if the credit facility is renewed, in an amount that tends to be similar to that of the opening fee.
  • Availability fee: it is a percentage of the money that has not been used when the time comes to pay interest on the credit.
  • Balance over limit fee: if you exceed the credit limit you were granted you will have to pay interest.

Together with these fees, there are another series of expenses related to taking out an insurance policy; However, it is worth pointing out that, like the other fees mentioned, these costs will depend upon which bank is selling the insurance policy. Some examples in relation to this are the study fee and the early repayment fee.

In summary, a credit facility is seen as a highly appreciated resource by many self-employed workers or small-medium businesses, because it can help them solve their problems related to unexpected liquidity needs. Once the credit facility has been approved the money can be obtained right away, without any further procedures required.

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