What Is Revolving Credit and How Does It Work?
If you need a flexible way of borrowing money, you might be interested in finding out more about revolving credit. It’s a credit line you can use to borrow and repay funds time and again. Although the total amount of credit is fixed, you can choose how much money you want to withdraw each time and how many times, as long as you don’t exceed the total amount of your credit line.
With this type of credit, you’ll be able to withdraw money for emergency cases or just your regular daily costs and pay that balance over time. Even though it’s a valuable financial tool, it’s not the ideal option for everyone, so let’s see how it works and how you can make the most out of it.
What Is Revolving Credit?
This type of credit lets you borrow a set amount of money, which you can later repay and then borrow again. The total amount of funds available to you is defined by a credit limit.
At the end of the statement period, you’ll receive a bill for the total balance spent. In case you don’t pay it in full or you just make a minimum payment, the remaining balance will get transferred to the next month, and you’ll be obliged to pay interest on it. As you pay off the revolving balance, more of your credit line will become available, and you get to spend it again. In short, this balance can be defined as the unpaid portion of your full credit amount. Most people apply for credit with the presumption that they’ll be able to pay it in full each month, but that’s not how it always works out, and many end up paying interest.
If you do manage to pay off the full credit statement balance at the end of the billing cycle, you can use the whole credit limit in the next billing cycle.
Types of Revolving Credit
There are three main subcategories of this class of credit: credit cards, personal lines of credit, and home equity lines of credit (HELOCs).
Credit cards can be viewed as a tool that will help you borrow money more easily to cover regular or unexpected expenses or improve your credit history.
Although credit cards can help you build your credit or cover your emergency or everyday costs, they also come with certain risks depending on how well you manage them.
Now, let’s take a look at the other two most common revolving credit options.
Personal Lines of Credit
With a personal line of credit, you get access to a fixed amount of money you can take out whenever you need it. Once you pay off the credit amount and the interest on it, you can repeat the whole process again.
Personal lines of credit are usually unsecured, which means you don’t need any collateral to cover them. This is one of the main benefits of this type of revolving credit. However, be advised that a personal line of credit can affect your credit score. Once you apply for it, the lender may perform a hard inquiry on your credit reports, which can cause a drop in your credit score.
Home Equity Line of Credit
A HELOC lets you borrow money by tapping the equity in your home. Your house would be used as collateral to secure this loan, which you should never take lightly, as you stand to lose it if you don’t repay the loan.
HELOCs are a form of revolving credit that can come with fixed or variable interest rates. You can draw on a HELOC for a fixed period, usually five to 10 years. After the draw period is over, the repayment phase begins. During this phase, you’ll no longer have access to additional funds and will have to make regular payments toward clearing your debt.
Revolving vs. Other Types of Credit
The main difference between revolving and other types of credit, such as installment loans, is that the latter usually come with a lower interest rate and don’t allow as much flexibility. With non-revolving credit, you can get a larger amount of money, and the life of the loan is usually longer. Also, having fixed monthly installments to pay makes planning your budget simpler because you’ll always know exactly how much you owe. On the other hand, once you borrow and repay an installment loan, the account is closed, and you can’t borrow those funds again.
Regardless of which type of credit you choose in the end, the same general rules apply: Carefully read the terms and conditions and stick to the repayment schedule to avoid hurting your credit score.
Pros and Cons of Revolving Credit
The benefits of this type of credit include:
- Easy application process. You can get approved within a few minutes.
- Flexibility. Draw the entire amount of credit or just a portion - it’s up to you.
- Collateral is usually not required. Note that HELOCs are an exception.
- Limited interest. With this kind of credit, you’ll only pay interest on the amount you’ve actually borrowed.
- Continual access to funds. You can borrow and repay your account balance over and over again.
- Cash back and travel rewards. Credit cards often come with rewards and bonus points you can collect to get discounts with some merchants.
There are also some disadvantages to consider:
- Maintenance and annual fees apply.
- Good credit required. If you wish to open a revolving credit account, your credit score needs to be 690 or higher or the lender might simply decline your application.
- Can impact your credit score negatively. If you fail to fulfill your obligations on time and repay your balance as agreed, your overall score will drop.
- Potentially high interest rates. Depending on the subtype, the interest rates can be as low as 5% for HELOCs and as high as 20% for credit cards issued to customers with less excellent or no credit history.
Tips on Maintaining Good Credit History
Any type of credit will most probably affect your credit score, and revolving credit is no exception. With that in mind, we’d like to share a few tips with you to help you maintain or improve your credit score.
- Set up automatic payments. The automatic payment should be for at least the minimum amount required. By setting it up, you’ll ensure to always make your payments on time. This is extremely important as your payment history makes up 35% of your overall score.
- Pay off your balance more than once a month. If you receive your paychecks more than once per month, it would be a good idea to pay off a portion of your revolving balance every time you get a paycheck.
- Increase your credit limit once every six months. This can help you keep your credit utilization rate lower. Ideally, it should be under 30%.
- Monitor your score. You can request your free credit report from any of the three major credit bureaus. Besides that, there are also various credit monitoring services that can keep an eye on your credit accounts for you. This will also protect you against identity theft.
A Flexible Way To Borrow Money
Revolving credit, by definition, is one of the most flexible ways of borrowing money as it enables you to repeatedly draw funds and pay them back over time. If you use the funds responsibly, make regular monthly payments, and don’t tend to overspend, this type of credit can help you manage your expenses with ease and build a stronger credit score. That being said, this credit product is meant for smaller and short-term loans, so if you need to borrow a significant amount of money, we advise you to explore alternatives such as various installment loans.
Some examples include credit cards, personal lines of credit, and home equity lines of credit, also called HELOCs. Depending on what you need the funds for, how much flexibility you want, and if you prefer a secured or an unsecured line of credit, you can choose among these three options. Most people already have at least one credit card and are familiar with how they work, but the other two options can also be convenient in some cases.
This type of arrangement will give you access to a fixed amount of money, which you don’t have to withdraw in its entirety. Instead, you can borrow just a portion you need that month and then repay it with interest. It’s called “revolving” because you can repeat this process multiple times, as long as the arrangement with your lender doesn’t expire. Once you pay off the balance in full, you can borrow the same funds again up to the agreed credit limit without having to apply for another loan.
Yes. Paying off a revolving account can help you increase your credit score, so if you need to improve it quickly, it would be best to start with paying off your credit card debts, as they have a much greater impact on your score than other types of credit such as installment loans. As you gradually pay off your debt, you’ll free the available credit, and your credit score will go up. If you have a credit card you’re using just for rewards and bonuses, it might be wiser to keep it as closing it down can negatively affect your score.
Credit cards are actually an example of this type of credit, along with personal lines of credit and home equity lines of credit. All of these options come with different benefits but also with risks and disadvantages you should carefully weigh before applying for any type of credit.
I have always thought of myself as a writer, but I began my career as a data operator with a large fintech firm. This position proved invaluable for learning how banks and other financial institutions operate. Daily correspondence with banking experts gave me insight into the systems and policies that power the economy. When I got the chance to translate my experience into words, I gladly joined the smart, enthusiastic Fortunly team.
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