There are many ways to get financing in the world today. Revolving credit is a great way to do this, and there are many ways in which you can access this type of credit.
Ready to learn more about how revolving credit accounts can help meet your financial needs while building your credit score at the same time?
What is revolving credit?
A revolving credit account is a type of account that gives you access to a line of credit from a lender that you can withdraw and repay on your own schedule. As you pay off the outstanding balance, you have access to use those funds again if and when you wish to do so.
It’s essential to use your revolving credit wisely. If you don’t pay off your balance in full each month, you’ll begin accruing interest. Depending on the types of revolving credit accounts you use, your interest rate could range widely.
How does revolving credit work?
Revolving credit is a type of credit that allows you to borrow money up to a certain limit, and then pay it back over time. You can use it over and over again, as long as you pay at least the minimum payment each month and don’t exceed your credit limit.
Here’s how it works:
- You apply for a revolving credit account, such as a credit card or a home equity line of credit (HELOC).
- The lender reviews your application and determines your credit limit, which is the maximum amount you can borrow.
- You can use your credit account to make purchases or withdraw cash, up to your credit limit.
- Each month, you’ll receive a statement showing your balance and the minimum payment due.
- You can choose to pay off your entire balance or just the minimum payment. If you pay off the entire balance, you won’t be charged interest. If you only pay the minimum payment, you’ll be charged interest on the remaining balance.
- As you pay down your balance, you’ll have more credit available to use.
Revolving credit can be a convenient way to borrow money, but it’s important to use it responsibly. If you don’t make your payments on time or exceed your credit limit, it can damage your credit scores and cost you more in the long run.
Examples of Revolving Credit
Here are some types of revolving credit available to consumers.
Unsecured Credit Cards
The most common type of revolving credit is an unsecured credit card. These credit cards aren’t security by collateral, such as a security deposit.
Credit card companies require a minimum payment each month, but you can set your schedule for repaying the bulk of the balance.
Just as with any type of financing, you’ll pay interest on your outstanding credit card balance. The average APR for a credit card is around 16%, but it can also go much higher depending on your credit scores and payment history on the credit card.
Secured Credit Cards
To obtain a secured credit card, a cash deposit must be made with the credit card issuer. This deposit, also known as a security deposit, acts as collateral for the credit card and is held by the issuer while the account is open. The amount of the deposit typically determines the credit limit for the card.
People with bad credit or no credit history, who don’t qualify for an unsecured card, are often recommended to get a secured credit card.
See also: Best Secured Credit Cards
Home Equity Lines of Credit
Another type of revolving credit is a home equity line of credit or HELOC. If you own a home and have enough equity, you can apply to borrow funds up to a percentage of that equity. Rather than receiving a lump sum, you draw funds from your line of credit as you need them.
The benefit here is that you’re not paying interest on the money you’re not using. So, for example, if you use your line of credit for a home renovation, you can withdraw funds each time you need to make a purchase or hire a contractor.
If the project is spread out over a period of time, you can save yourself money on accruing that interest. Plus, HELOC rates are typically much lower than those associated with credit cards and even personal loans.
How does revolving credit affect your credit score?
Your credit scores can be affected by your use of revolving credit in several ways:
- Payment history: Late or missed payments on your revolving credit accounts can negatively impact your credit score.
- Credit utilization: Your credit utilization, or the amount of credit you are using relative to your credit limit, is an important factor in your credit score. High credit utilization, or using a large percentage of your available credit, can hurt your credit score.
- Credit mix: The types of credit you have can also affect your credit score. A mix of different types of credit, such as a mortgage, a car loan, and a credit card, can be beneficial for your credit score.
- Length of credit history: The longer you have had your revolving credit accounts open, the better it is for your credit score. This is because a longer credit history suggests stability and responsible credit management.
One benefit of having a revolving credit account is that lenders typically report your positive payments to the major credit bureaus. So if you want to build your credit from scratch or repair it from past financial issues, then revolving credit is one way to do that.
Used responsibly, a revolving line of credit can help strengthen your credit report and credit score. As long as you keep your credit utilization ratio relatively low and make at least the minimum monthly payment on time, you can build a positive credit history.
Revolving Credit vs. Installment Credit
There’s a big difference between revolving credit and an installment loan — most notably in how the borrowed funds are repaid. We discussed how you can pay revolving credit at your own pace while accruing interest.
With installment loans, on the other hand, you have fixed monthly payments. The principal and interest are spread out over a predetermined repayment term. For example, you may have an installment loan that lasts over the course of three years.
As long as you agreed to a fixed interest rate, your payment is due in full every month, and the amount should be the same each time (assuming you’ve paid on time in the preceding months.)
Lines of revolving credit typically don’t have fixed interest rates but instead have variable APRs. Credit card issuers can increase your rate at certain times, including if you miss payments.
A HELOC is typically tied to the prime rate. So, whatever that number is set at, you can usually expect to pay a point or two more. Depending on your lender, there may be a cap on how high the rate can go.