Revolving credit is credit that you can borrow on an ongoing basis. It has an interest rate, a spending limit, and a monthly payment. Revolving credit allows you to repeatedly borrow money up to your limit as you gradually repay what you owe over time.
You are probably more familiar with revolving credit than you think. If you have ever used a credit card, taken out a personal line of credit, or had a home equity line of credit, you have used revolving credit.
How Does Revolving Credit Work?
When approved for revolving credit such as a credit card or a home equity line of credit, the lender will set a credit limit. This is the maximum amount you can charge to the account.
Your available balance lowers as you use the credit card, which will roll over into the next payment cycle. The amount available only refreshes as you pay down the balance. For instance, if you have a $1000 credit limit and have used $500, that leaves you with $500 available. If you make a $300 payment, your credit limit is up to $800.
A revolving credit account is an open-ended account with no specific end date. If you keep the account open and make the required payments, you can continue using it.
When you revolve a credit account balance, you will have a minimum payment to keep your account current and in good standing. Minimum payments may be a fixed amount or a percentage of your total balance, whichever is higher; you can find specifics in the fine print of your revolving credit agreement.
Revolving Credit Examples
Many revolving credit account products are available for consumers to choose from based on their needs and credit situation. Credit cards are the most commonly used revolving credit accounts that people use. There are also home equity lines of credit and personal lines of credit available.
- A credit card is a line of credit used to borrow money to make purchases, transfer balances, and get cash advances, with the agreement that you’ll pay back the money borrowed — plus any interest you owe on it — at a later date. As with other revolving credit products, the lender establishes a preapproved amount, and you cannot withdraw over that amount.
- With a personal line of credit, you choose when to take advances instead of a term loan, where you receive a lump sum at the beginning and start paying interest on it immediately. You only pay interest on the amount you’ve drawn from a personal line of credit. Once the amount drawn out of the personal line of credit is paid, that amount is available for you to borrow from again immediately during your draw period.
- A home equity line of credit (HELOC), unlike a conventional loan, is something you establish ahead of time and use when and if you need it. It’s like a credit card, except your home is used as collateral with a home equity line of credit. A HELOC has a credit limit and a specified borrowing period, typically ten years. You can withdraw the money you need but only up to the amount approved by the lender during that time. You use the funds only as you need them, and you can continue to use the funds as you repay them.
Types Of Revolving Credit
Revolving credit accounts can be unsecured or secured. Each of these accounts has very different features.
A secured revolving credit is guaranteed by attached collateral such as a home equity line of credit (HELOC) or a secured credit card, in case you cannot make payments anymore. For example, a secured credit card is secured with a cash deposit while the home’s value ensures that your home equity line of credit (HELOC) will be paid if you default or cannot pay. When you apply for a secured credit card, the deposit amount will usually be your credit limit.
Unsecured revolving credit is not guaranteed by collateral or an asset like a personal loan or a credit card with no cash deposit. In most cases you will have higher interest rates when you have an unsecured loan, because the lender assumes more risk with an unsecured credit product.
A home equity line of credit (HELOC) is secured with your home’s equity and will have a lower interest rate than a personal line of credit that is unsecured and has no collateral attached.
The only exception is secured credit cards, which have higher interest rates than unsecured credit cards. If you do not qualify for a traditional credit card because of your credit history, you can qualify for a secured credit card. The lender will approve secured credit cards with collateral even with poor credit history, and a benefit is that these cards can help reestablish your credit.
Revolving Credit vs. Installment Loan?
There are two types of credit repayments: revolving credit and installment credit.
Revolving credit is a credit card or line of credit that allows borrowers to spend the borrowed money, repay it, and spend it again. The lender issues a set credit limit that can be used at once or in parts until the account is closed.
Installment loans have a predetermined length and end date. Anyone with a mortgage, auto loan, student loan, or personal loan has an installment loan. When you sign an agreement for an installment loan, you will receive the terms of the loan, which have a set payment amount and length of payment time.
An installment loan like a mortgage can only be used on your home, while a home equity line of credit allows you to spend money on whatever you need as you need it.
As Investopedia notes, “revolving credit can be a more dangerous way to borrow than installment credit”. A big part of your credit score (30%) is your credit utilization ratio—for example, how close your card balance is to your overall limit on each card. Carrying high balances drags down your score.
What Is Revolving Credit Good For?
Revolving credit is good for flexibility in spending month to month. It has one significant advantage over installment loans: You can use just the amount of credit you need at any given time, and no more, up to the limit. You can pay your revolving credit account down, and if you need more credit next month or next year, you’ll be able to reaccess it. It allows flexibility in what you spend the funds on and how much you spend.
It can also be beneficial to use credit cards to earn rewards and cash back as long as you pay off the balance on time every month.
Many of us have revolving credit accounts, and they can be beneficial if managed properly. They can free up additional funds with secured and unsecured products, and if you pay off the balance used, you have the option to use the available credit as needed.
As with any credit product, it is essential to understand the terms of the agreement, such as interest rates and due dates, if you have a balance on the account. Remember, with revolving credit you may not only pay interest on your balance, but you may also pay annual fees and any late fees or over-limit fees, if applicable. Always compare products to find the best one for your credit situation and needs.