By Sami Guwal
KEY TAKEAWAYS
- Revolving credit encompasses various options like credit cards, personal lines of credit, and home equity lines of credit (HELOCs).
- Advantages of revolving credit include flexibility and access to funds, but it can lead to debt if not managed responsibly.
- Revolving credit significantly impacts credit scores, with timely payments and low credit utilization being crucial.
- Compared to installment loans, revolving credit differs in repayment structure, credit impact, and loan purpose.
- Responsibility is essential when using revolving credit, emphasizing timely payments and credit monitoring for financial well-being.
What is Revolving Credit ?
Revolving credit can be beneficial in various situations, especially when you require access to funds that you can repay gradually over time. However, it’s essential to use revolving credit responsibly, as mismanagement could lead to financial difficulties.[1]
Revolving credit is a type of credit that allows you to borrow money up to a certain limit, repay it, and then borrow again as needed. Unlike installment credit, where you receive a lump sum and repay it in fixed installments over time, revolving credit provides you with a line of credit that you can use flexibly.
Examples of revolving credit include credit cards, home equity lines of credit (HELOCs), and personal lines of credit.However, it’s essential to use revolving credit responsibly, as mismanagement could lead to financial difficulties.
Contents:
Pros and Cons of Revolving Credit:
Pros:
Flexibility: Revolving credit offers borrowers the flexibility to access funds as needed, providing a steady source of cash flow for businesses during fluctuating costs and sales.
Vital for Business: Many businesses, both small and large, rely on revolving credit to maintain consistent access to funds, especially during seasonal fluctuations.
Borrowing Costs: By paying down balances regularly, both consumers and businesses can minimize borrowing costs, as interest is typically charged only on the outstanding balance.
Cons:
Risky Borrowing: Revolving credit can be risky if not managed carefully, as it can lead to high levels of debt accumulation.
Impact on Credit Score: A significant portion of one’s credit score (30%) is determined by the credit utilization rate, which can suffer if revolving credit balances are consistently high.
Variable Interest Rates: Depending on factors such as credit history and collateral, interest rates for revolving credit can vary widely, potentially leading to higher borrowing costs for some borrowers.
Understanding Credit Cards vs. Lines of Credit:
Revolving credit includes things like credit cards, home equity lines of credit (HELOCs), and personal or business lines of credit. While many people know about credit cards, there are differences between them and other types of revolving credit.
First, with a line of credit, you don’t get a physical card like you do with a credit card. Instead, you can access the money through checks provided by the lender.
Second, you don’t have to buy something to use a line of credit. You can get money transferred straight into your bank account for whatever you need, without having to make a purchase. It’s a bit like a cash advance on a credit card, but it usually doesn’t have as many fees or high interest rates.
How to revolving credit works ?
When you open a revolving_ credit account, you’re given a credit limit, which is the maximum amount you can spend. At the end of each billing cycle, you receive a statement showing your balance, or how much you owe. Then, you have two choices:
- Revolve part of the balance to the next month. You can’t carry over the entire balance; you must make at least a minimum payment, specified in your agreement. This can be a fixed amount, like $25, or a percentage of your balance. If there’s no 0% introductory interest period, any carried-over balance starts accruing interest, adding to your total balance.[5]
- Pay off the balance in full by the due date, and no interest will accrue.
Borrowers must pay monthly interest on the remaining balance.Borrowers must pay monthly interest on the remaining balance. Banks may periodically review the account and may increase the credit limit for customers who have demonstrated responsible usage and repayment behavior. This increase in credit limit can encourage customers to spend more within their means and can be seen as a sign of trust from the bank.
Due to its flexibility and convenience, revolving_ credit often carries higher interest rates compared to traditional installment loans. Revolving- credit may feature variable interest rates that can fluctuate. The expenses associated with revolving credit can vary significantly:
- Home equity lines of credit (HELOCs) typically offer interest rates slightly higher than those of mortgages. HELOCs act as secondary mortgages, leveraging home equity as collateral.
- Conversely, credit cards generally come with much higher average interest rates. As of April 2023, the average interest rate on credit cards surpassed 20%.[2]
Types of Revolving credit cards:
Revolving _credit comes in two main types: secured and unsecured. They have significant differences between them.
Secured Line of Credit: This type of credit is backed by collateral, like a home with a Home Equity Line of Credit (HELOC). If you can’t repay the loan, the lender can take possession of the collateral to cover the debt.[3]
Unsecured Revolving_ Credit: This type of credit doesn’t require collateral or any asset to back it up. For example, a regular credit card doesn’t need collateral. However, there are secured credit cards where you deposit cash as collateral.[4]
Understanding these differences can help you choose the right type of revolving credit for your needs.
Exploring Your Revolving Credit Options:
Credit Cards: These handy cards let you make purchases up to a certain limit. You pay back what you spend, plus any fees and interest. If you pay off your balance within a specific time frame, usually around a month, you won’t be charged extra. Plus, some cards offer cool rewards for your spending, like cash back or travel perks.
Personal Line of Credit: Some banks and credit unions offer these flexible loans. You can borrow money up to a set limit whenever you need it. During the ‘borrowing period,’ which typically lasts a few years, you can access funds through your bank card or checks. You’ll pay back what you borrowed with monthly payments that can vary. As you pay off what you owe, you’ll have access to more funds. Once the borrowing period ends, you’ll pay off the remaining balance with fixed monthly payments.
Home Equity Line of Credit (HELOC): This type of credit uses your home as collateral. You can borrow against the equity you’ve built up in your home, which is the difference between its value and what you still owe on your mortgage. HELOCs usually have a period where you can borrow money (the ‘draw period’), followed by a time to pay it back. During the draw period, you can access funds as needed, and then you’ll pay back what you owe over a set period of time.
How Revolving Credit Can Benefit Your Credit Score :
- Timely Payments: Paying your bills on time is crucial for improving your credit score, as it’s the primary factor considered. Setting up autopay for at least the minimum payment on revolving_ credit accounts can help you avoid late payments.
- Building Credit History: Without credit accounts, you won’t have a credit score. Getting a credit card and consistently paying off the balance each month is a simple way to establish a history of responsible credit usage. Credit cards provide insight to lenders on how well you manage debt because they allow you to decide how much to charge and repay monthly.
- Diversifying Credit Mix: Having a variety of credit accounts, including both revolving and installment credit, can enhance your credit score. If you currently only have installment credit (like a student loan and a car loan), adding a revolving credit account can diversify your credit mix and potentially boost your credit score.
Comparison between revolving credit and installment loans:
| Aspect | Revolving_ Credit | Installment Loans |
|---|---|---|
| Repayment Structure | No fixed number of payments or set period | Fixed number of payments over predetermined period |
| Payment Requirements | Minimum payment plus fees and interest | Fixed payments including interest |
| Credit Impact | Significant influence on credit score | Generally viewed favorably if payments are timely |
| Pre-Approval | Borrowers are pre-approved | Requires formal loan application and evaluation |
| Loan Purpose | Typically shorter-term and smaller loans | Commonly used for larger loans |
Botton line:
Revolving_ credit offers flexibility for both everyday spending and occasional large purchases. A strong credit score can unlock better terms, like lower interest rates, when accessing revolving credit. Before applying for credit, review your credit report and score. If necessary, consider actions to improve your score before seeking credit.
