What Is Revolving Credit and How Does It Work?

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If you use a credit card, you’re familiar with revolving credit. 

Revolving credit is credit that you can borrow on an ongoing basis. It has an interest rate, a spending limit, and a monthly payment. 

There are different types of revolving credit, but the most common are credit cards. Revolving credit can also come as a home equity line of credit (HELOC).

“Revolving credit allows you to borrow money repeatedly up to your limit as you repay what you owe gradually over time,” says Dani Pascarella, CFP, the founder and CEO of OneEleven, a financial wellness platform. 

But be careful; just because you have a credit limit doesn’t mean you should use it all. Read this article to learn more about revolving credit, and how to use it without getting into debt.

What Is Revolving Credit?

Revolving credit is a lot like it sounds: it’s an open and ongoing line of credit that lets you spend up to a certain limit.

You can spend up to your credit limit.  The more you pay off each month, the more credit becomes open for use. 

“A revolving credit account sets the credit limit, which is the maximum amount one can spend on that account,” says Pamela J. Sams, a financial advisor at Jackson Sams Wealth Strategies. “One can choose either to pay off the balance in full or to carry over a balance from one month to the next, thus revolving the balance.”

When you use credit from credit cards, you should always pay your balance off in full each month. That way, you’re not paying interest on the money you’re borrowing. Making sure you stay on budget and on track of your finances will allow you to have the funds to pay the debt. 

When it comes to using a HELOC as revolving credit, you essentially are taking out a second mortgage on our home. You need equity in your home in order to qualify for a HELOC. Getting a HELOC can give you access to large amounts of cash for renovations, debt repayment, or other large purchases. But remember that HELOCs use your home as collateral. If you default on your payments, you run the risk of foreclosure on your home. 

How Does Revolving Credit Work?

When you are approved for revolving credit, there is a credit limit, or the maximum amount of money you have access to. With revolving credit, you can keep it open for months or years until you close the account. If you are a dependable customer, you might get credit raises to entice you to spend more money.

At the end of each pay period, you’ll have a minimum amount due. This amount is usually a small percentage of your total balance due. If you carry a balance,  you’ll get hit with an interest charge on that amount. However, if you pay off your balance in full, you’ll skip the interest charge. Essentially, this is interest-free borrowing.

Make sure you pay your balance off in full every month when using revolving credit. You don’t want to pay unexpected interest and fees associated with the money you borrow. 

How Is Revolving Credit Different from Installment Credit?

An installment loan lets you borrow a set amount of money and you repay it over a specific period in fixed monthly installments. These types of loans include auto loans, student loans, and mortgage loans. But one you pay off the amount owed, the account is closed and you aren’t entitled to anymore. 

Both revolving credit and installment credit impact your credit score. But there are some differences between them.

“Unlike revolving credit, installment credit is a one-time loan that is paid off through fixed payments over a set period of time,” Pascarella says. Here are a few standout features:

  1. How many times you can borrow. Revolving credit allows you to continuously borrow money, while installment credit is meant for one-time borrowing.
  2. Your reason for borrowing Because you can withdraw over time with revolving credit, there usually isn’t one set purpose for what you’re spending it on. On the other hand, installment credit is typically borrowed for one specific reason like buying a car, or taking out a student loan for the semester.
  3. Interest rates. Revolving credit will typically have a much higher interest rate, which can be as much as six to seven times that of installment credit.

While you can use both for various reasons and at the same time, they have different purposes.

How Does Revolving Credit Affect Your Credit Score?

Your credit use, referred to as credit utilization, is how much debt you carry from month to month on all your available credit lines compared to your total available credit. So if you have one credit card with a $5,000 limit and carry over a $4,000 balance from the previous month, your credit use is 80%, which is very poor. 

“The lower your credit utilization rate, the better off your credit score will be,” Pascarella says. “Ideally, you should aim to use less than 30% of the credit available to you to keep your credit score in good shape.”

Along with that, falling behind on payments — even minimum payments — can impact your score. Payment history is the most important factor in your credit score, making up 35% of it. 

But you can use your revolving credit score for good, Sams says.

“Depending on how one uses it, revolving credit can either help or hurt a credit score,” Sams says. “If one is just starting out and has little or no credit history, getting a credit card and using it for smaller purchases and paying on time every month is a good start to building credit.”

How Not to Carry a Revolving Balance

Responsible credit usage is one of the most important parts of hanging onto revolving credit or any other type of credit. Here’s how to handle revolving credit to build your credit score or keep it strong.

  1. Don’t spend more than you can afford. Make yourself a budget and only use your card for purchases you know you can pay back when your bill is due. Treat it like a debit card, but with some perks and incentives.
  2. Find the right card for your needs. If you want cash back rewards, find the one that maximizes where you spend the most. For instance, if you have a large family and do a lot of grocery shopping, find a card that offers the most cash back from grocery stores. For travel, find a card that rewards you in points or miles.
  3. Set up payment reminders. If you want to make sure you never miss a payment, set up a calendar reminder the day your payment is due. But even better, set up autopayments instead.
  4. Remember this isn’t free money. A credit card or a personal line of credit lets you pay for goods but you still owe money to your credit card for this service. It’s not free money, it’s money you’ll later pay back — and possibly with interest.