Revolving credit is a type of credit that has a defined limit from which you can borrow at any time, and has no set end date. Generally, credit cards, personal lines of credit and HELOCs are revolving credit accounts. Here’s how revolving credit works, the pros and cons and how to use it responsibly.
Consumer credit is categorized as either revolving credit or installment loans.Your car loan, mortgage and any other loan with set payments and payoff date are installment loans. All other credit accounts, including credit cards and lines of credit, are generally revolving credit.
How does revolving credit work?
The main characteristic of revolving credit is that the balance “revolves,” or carries forward, from month to month.
A certain amount of revolving credit is extended to you by the bank or other lenders. You are only allowed to use up to this credit limit.
Unlike an installment loan, such as a car loan or a home mortgage, there is no set end date to revolving credit. The balance can go up or down over time, again and again. If you pay off your balance, the account remains open. You can use the credit again whenever you want.
You pay interest only on your balance with revolving credit. You may also pay annual fees, and any late fees or over-limit fees, if applicable.
See related: How do credit cards work?
Types of revolving credit
You may already have one or more forms of revolving credit. Common types of revolving credit include:
- Credit cards. Credit cards are classified as revolving credit because you have a set credit limit, you can use as much or as little of the credit limit as you want, any balance on the account “revolves” to the next month and the account remains open when the balance is zero. You typically use credit cards to make purchases. If you take a cash advance from a credit card, you may have to pay additional fees, and sometimes a higher interest rate on cash advances than on purchases.
- Home equity lines of credit (HELOCs). HELOCs are also revolving credit. They typically charge lower interest rates than credit card accounts, because they are secured by real estate.
- Personal lines of credit. If you take out an unsecured revolving bank loan, it’s called a personal line of credit. The ability to borrow from a personal line of credit, and pay it off when you can, is useful when you have uneven income or expenses.
- Business lines of credit. If you own a business, you may get a business line of credit for cash needs. A line of credit can help with your cash flow if your business is seasonal, for example, or if you must pay expenses before you receive enough revenue to cover the expenses.
What are the advantages of revolving credit?
- Flexibility. Revolving credit has one big 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, knowing that if you need more credit next month or next year, you’ll be able to access it again.
- Credit score benefits. Handling revolving credit well is a good indicator of credit risk. Experian says that at least one positive credit card account will benefit your credit score.
- Credit card rewards. Using your credit card for purchases can help you rack up rewards quickly. You may get airline miles, other perks or even cash back, depending on your credit card.
- Ability to get cash. Unlike installment loans, which are typically used to purchase something, a revolving line of credit allows you to withdraw cash for your needs. You may also be able to withdraw cash from a credit card, although there may be additional fees.
See related: How to apply for a credit card and get approved
What are some disadvantages of revolving credit?
- No set end date. If you want a structured loan payoff plan that tells you exactly when you’ll have a debt paid off, revolving credit may not be for you. Your revolving credit balance can even go up as well as down, if your additional purchases or withdrawals and interest expense are greater than your payments. For example, if you buy a car on a typical installment loan, you make your payments and know that by a certain date, you’ll own your car free and clear. If you take out a home equity line of credit and use the proceeds to buy a car, or you take cash advances to buy a car, you don’t have a set payment schedule with an end date.
- Fees and interest. Some revolving credit lines, such as lines of credit, may require a commitment fee when you open the account. Your interest rate may also be higher on some types of revolving credit, such as credit cards, than you would pay on an installment loan.
- Possibly lower limits than traditional loans. If you need the maximum amount you can borrow, you may qualify for a higher limit with a traditional loan than with revolving credit.
See related: Understanding credit limits and how they work
How can I use revolving credit well?
Revolving credit can be a great payment tool, and financing tool when you need it. If you keep close tabs on your balance, and pay any balance off as quickly as possible, you’ll minimize your interest expense and keep your credit line available in case you should need it.
Another reason to keep your balances on revolving credit as low as possible is to maximize the benefit to your credit score. Credit scores look at your balance-to-limit ratio, also known as credit utilization. The more of your available credit you are using, the higher your utilization rate. The lower your rate, the better for your score.