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How Does Revolving Credit Work?

 Published on December 23, 2022

How Does Revolving Credit Work?
What is revolving credit? It probably plays a bigger role in your life than you might have realized if this is a term you’ve never heard before. If you have a credit card sitting in your wallet, or if you’ve ever been approved for a personal line of credit, you probably have some familiarity with how it functions. Having said that, it can be a vital part of your finances and your overall financial profile, so it’s important that you have a detailed understanding of how it works. So, with this in mind, we’ll start by giving a revolving credit definition, walk through some common examples of it, and highlight some of the key differences between revolving credit and other common types of personal loans.

What is Revolving Credit?

The best place to start is by answering the question we asked at the top. In simple terms, revolving credit constitutes a personal loan that gives you the ability to borrow funds on a continuous basis. If you get approved for a revolving credit account, you’ll be given a credit limit that you can draw funds up to. Essentially, this limit is the most amount of money you can possibly draw on this account at one time. If you draw less than your total limit, that amount will be subtracted from your limit, and the amount of credit you still have available to you (before you pay back what you owe) will be whatever is left over. For example, if you have a $2,000 credit limit and you draw $1,500 from it, you’ll be left with $500 in available credit. As you continue to pay down what you’ve borrowed, along with any necessary interest and/or fees, you’ll be able to borrow money again on a continuous basis. Another way of thinking about revolving credit, and another term that’s used to refer to the same borrowing structure, is as open-ended credit. In contrast to something like an installment loan which closes once you pay it off, there isn’t usually an end date with something like a credit card or line of credit. So, as long as you keep your account in good standing and don’t make the decision to close it, it’ll typically stay open.

3 Common Revolving Credit Examples

Like we’ve already said, there’s a good chance that you have some familiarity with revolving credit accounts of some sort already. But if not, or if you want to learn a bit more about some of these types of credit, here’s a list of three of the more common types of revolving credit and what you’d typically use each for.

1. Credit Cards

If there’s one kind of revolving credit you’re likely familiar with, it’s probably a credit card. Their general purpose is to be used for everyday transactions. One of the reasons people use them so regularly is because they usually come with some sort of reward. This could be something like cashback rewards or travel points that you can put towards booking flights or accommodations. Whenever you make a purchase, pay off your credit, miss a payment, or some other kind of activity occurs on this account, it’ll be reported to a credit bureau. Because of this, your credit cards can have a relatively substantial impact on your credit history, particularly if you’re using them frequently. You’ll want to make sure that you keep up with all your payments in a timely manner, which is something you’ll want to do with any set of bills.

2. Personal Revolving Line of Credit

Broadly speaking, credit cards and lines of credit function fairly similarly. With both these credit accounts, you’ll be given a credit limit to draw from, assuming you’ve been approved for one. You can even use lines of credit for everyday purchases as you would a credit card, depending on the type of line of credit and what its intended use is. Having said that, they’re often intended to be used for emergency expenses when your savings fall short. One big distinction is that your line of credit won’t come with a card that you can use to access your funds. Instead, you’ll generally need to request a draw from the lender that your line of credit is with and from there, your funds will be deposited into your bank account. There are certain variables that determine how quickly those funds will be deposited into your account, but it could be as soon as the same business day in some instances.

3. Home Equity Line of Credit (HELOC)

Unlike credit cards and your typical personal lines of credit which are generally unsecured loans, a HELOC is a secured loan. With a secured loan, you’ll need to provide the lender with some kind of collateral in order to qualify for the loan. With an unsecured loan, no collateral will be required, but this means that interest rates on these loans tend to be higher than they typically would be with secured loans. White house with white picket fence. In order to secure a HELOC, you’ll need to provide whatever equity you have in your home as collateral to secure your loan. Aside from this, the basic structure and function is generally the same as it is with any line of credit. Having said that, HELOCs typically aren’t meant to be used for everyday purchases. Generally, their intended use is for home improvement projects. Specifically, if you’re embarking on some sort of large renovation but you aren’t sure what the exact cost of it is going to be, the flexibility that comes with a HELOC can be a huge help.

What are the Differences Between Revolving Credit Accounts and Installment Loans?

We’ve already briefly mentioned one of the main differences between revolving credit and installment loans. Let’s take a closer look at that key distinction as well as another important difference that may impact your decision if you’re deciding which type of loan works best for you.

1. Closed-End Loans vs. Open-Ended Loans

Like we’ve mentioned, with a revolving credit account, you can draw funds on a recurring basis, and you can choose how much to draw if it’s within your credit limit and you have available credit. This makes it a relatively flexible borrowing option. With a closed-end loan like an installment loan, you’ll receive your funds in a lump sum and if you need more money, you’ll need to apply for another loan.

2. The Repayment Process

When it comes to paying back an installment loan, the process is fairly different than it would be for a revolving credit account like a credit card or line of credit. With an installment loan, you’ll need to repay your loan over a series of scheduled payments that will be pre-determined and of equal value. The repayment period could span several months or years, depending on the type of loan. This can be a useful structure if you like the idea of being able to schedule all your payments into your budget ahead of time, and if you like the spread-out nature of the repayment process. If you do find that you have a bit of extra room in your budget that you want to designate towards paying off your installment loan, then you can consider trying to pay off your loan early. Having said that, some lenders will charge an early repayment fee, so you’ll want to make sure that you look into whether or not that’s the case for the loan you’re paying back. person looking at revolving credit info on their phone. The nature of repaying a revolving credit account is a little more fluid. You’ll likely have a billing cycle that sometimes ends at the end of each month, and you’ll need to pay back what you owe by the end of your cycle. However, the amount that you’ll need to repay can change from one cycle to next depending on how much money you’ve drawn. On top of that, you’ll be required to make a minimum payment, which is the minimum amount of money you’ll need to pay to keep your account in good standing. It’s always a good idea to pay more than the minimum payment if you can afford to.

Research your Borrowing Options

It’s not always easy to navigate the world of borrowing. New terms are thrown at you regularly, one financial product may look much like another, and it can be hard to figure out what’s best for your situation. The problem is, it’s tough to deny how important a role your finances play in your life, and it’s on you to get a good grasp on your situation and the world around you. The key here is to take the time to educate yourself, learn as much as you can, and put that knowledge to good use. If a term like revolving credit confused you before, we hope we’ve helped to clear the air!

Disclaimer: This page provides general information only and does not constitute financial, legal or other professional advice. For full details, see Fora’s Terms of Use.