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Your car broke down. Bed bugs infested your mattress. Your child needs stitches from a bike accident. These bills come to $3,000, but you only have $2,000 in your checking account. What can you do? You could borrow money.
Unlike a non-revolving line of credit, a revolving line of credit enables you to borrow the money you need for daily expenses or in an emergency and pay the balance over time. Revolving credit enables business owners and households to better manage their cash flow, cover unexpected expenses and to better plan their budgets.
We see many examples of revolving credit, including personal lines of credit and HELOCs (home equity lines of credit), which can be useful for home remodeling and repairs. Credit cards are a popular form of revolving credit. These can be used for large and small cash expenses while offering travel rewards, cash back and repayment flexibility.
Newer credit borrowers generally have easier access to credit cards, while banks may be more strict in approving personal lines of credit and HELOCs.
How Revolving Credit Work
With a revolving line of credit, borrowers get access to a set amount of funds that can be borrowed, repaid and then borrowed again. This feature makes revolving lines of credit a useful option for individuals and businesses who want to use revolving credit to pay for ongoing expenses or manage cash flow.
The set amount of funds is defined by a credit limit, which is the maximum amount a borrower can spend on the account. As you spend more on the revolving credit account, your balance accumulates. You’ll compile a transaction history and all of your charges will appear on your bill at the end of the billing cycle.
If you completely pay off the revolving credit statement balance in full and on time at the end of the billing cycle, you’ve settled the account and can enjoy the use of the whole credit limit again in the next billing cycle.
If you make the minimum payment or any amount less than the statement balance, you’ll be charged interest on the balance that is carried over in each subsequent month; the available credit limit in the next statement cycle will decrease by the balance and interest charges that “revolved” into the next billing cycle.
A minimum payment could be a fixed amount or a percentage of the total statement balance, and details can be found in your revolving credit agreement. Sometimes, newly issued credit cards or lines of credit have promotional rates, like a 0% interest introductory period.
With a 0% introductory offer, interest is not due during the introductory period, but cumulative interest is usually due after the introductory period ends if the balance is not paid off in full. It’s important to remember to pay off the balance in full at the end of the introductory period to minimize interest payments.
How Revolving Credit Is Different from Non-Revolving Credit
Installment loans are a type of non-revolving credit. They usually require a fixed number of payments over a set period of time. In contrast, revolving credit requires only a minimum payment plus interest and fees. Revolving credit is intended for short-term and small loans, while installment loans are intended for long-term and large loans to purchase cars, education, business equipment or homes.
The use of revolving credit can have a faster impact on your credit score—in both directions. Once you pay your statement balance off or run up a big bill, you’ll see those impacts within one to two months.
How to Get Revolving Credit
Revolving credit is available from banks and other lending institutions, and the application process is similar to a traditional loan. Carefully review the terms of your credit application, and follow these steps to apply for a personal or business revolving credit line.
- Choose a lender
- Compile the necessary documentation
- Complete an application
- Identify collateral and have it appraised (if secured)
- Wait for the loan underwriter’s review
- Receive approval and close on the line of credit
Approval time can vary depending on the complexity of your application, the type of credit application or the lender’s review process. For example, a secured line of credit will require additional time for your lender to review your collateral, have it appraised and confirm that it meets minimum requirements.
Pros of Revolving Credit
- Flexibility: Revolving credit allows individuals and businesses to borrow what they need and pay it back over time or at the end of the billing cycle. Credit cards, personal lines of credit and HELOCs are especially flexible with few restrictions on how borrowers may use the credit account.
- Easy application process: Borrowers may often be approved within minutes.
- Lower interest rates compared to some other ways to borrow money: Interest rates on revolving credit is generally lower than cash advances or payday loans. Rates are even lower for HELOCs—most borrowers with good credit can expect to pay between prime plus 2% and 10%.
- Collateral may be optional: Unless you apply for a secured line of credit, collateral is typically not required to open a line of credit.
- Continuous access to funds: With a revolving line of credit, borrowers can draw on and repay the account balance repeatedly.
- Limited interest: Unlike a traditional loan, interest on revolving credit is limited to what you actually borrow.
- Travel rewards and cash back: Many credit cards offer rewards for their use, and sometimes purchases in certain merchant categories earn additional bonuses.
Cons of Revolving Credit
- Good to excellent credit required: Lenders typically reserve lines of credit for borrowers with good or excellent credit, with scores of 690 or higher. The credit requirements for secured lines are usually lower than those for unsecured.
- Maintenance or annual fees: Depending on the lender, annual maintenance fees or cardmember fees may be charged for the account. Borrowers also may be subject to late or returned payment fees.
- Higher, more variable interest rates compared to non-revolving credit: Average interest rates may be higher than non-revolving credit products, like mortgages and auto loans.
- Interest is not tax-deductible: Unlike mortgages, student loans and business loans, interest accrued is not tax-deductible. Although business credit cards can help segregate business expenses, personal expenses charged to business accounts are not tax-deductible.
- Can negatively impact credit score: Poorly managed credit, both revolving and non-revolving, can damage your credit score if you fail to make timely payments or if you carry a high balance over time.
Revolving Credit Can Be a Useful Financial Tool
All types of credit affect your credit score, but revolving credit accounts can help or hurt your score more quickly depending on how they are managed. If you’re a new borrower with no or little credit history, using a secured credit card for small purchases and paying in full and on time every month can help build a good credit score.
Credit utilization, age of credit, number of inquiries and payment history all impact your credit score. Revolving credit has the ability to impact all of these categories.
Here are some key tips for maintaining a good credit history with revolving credit:
- Set up auto-payment on the minimum payment (or the full balance). By setting up auto-payment for at least the minimum payment, you’ll automatically make your payments on time. Payment history makes up the largest portion of your score (35%).
- Call your credit card company to increase your credit limits as often as once every six months. Having a higher credit limit will help keep your credit utilization low. However, be aware that the issuer could do a hard credit check, which could lower your score.
- Pay off your balance more than once per month. Balances are reported once every thirty days, but many people receive paychecks more than once per month. It may help with your cash flow to make payments to your revolving credit balances every time you receive a paycheck.
Is Revolving Credit For You?
Revolving credit can be used to conveniently pay your mobile phone bill every month with a credit card or remodel your kitchen with a HELOC. These are useful for ongoing purchases and one-time expenses. When used responsibly, revolving credit can help you manage cash flow and build a strong credit score, which are both key to healthy personal finances.