Revolving credit is a type of credit facility that provides borrowers with ongoing access to a predetermined amount of funds. This credit line remains open even as the borrower makes payments, allowing them to borrow and repay repeatedly.
Key Facts
- Definition: A revolving credit card is a line of credit that remains open even as you make payments. It allows you to borrow money up to a preset credit limit and repay the balance in full or make regular payments.
- Access to Funds: With a revolving credit card, you have ongoing access to a certain amount of credit. As you make purchases and use the funds, your available credit decreases. However, every time you make a payment, your available credit goes back up.
- Interest Charges: If you carry a balance on your revolving credit card, you will be charged interest on the outstanding amount. The interest rate on revolving credit cards is typically higher compared to traditional installment loans.
- Types of Revolving Credit: Credit cards are the most common type of revolving credit. They allow you to make purchases, repay the balance, and use the credit again. Other examples of revolving credit include lines of credit and home equity lines of credit (HELOCs).
- Credit Utilization: Revolving credit cards can impact your credit score. It is recommended to keep your credit utilization ratio (the proportion of your balance to available credit) below 30% to maintain a good credit score.
How Revolving Credit Works
When a borrower is approved for revolving credit, the lender establishes a credit limit. This limit represents the maximum amount of funds the borrower can access. Unlike installment loans, revolving credit does not have a fixed repayment schedule. Instead, borrowers can use the funds as needed, up to the credit limit.
As the borrower makes purchases or withdraws funds, the available credit decreases. However, as they make payments, the available credit is replenished. This ongoing access to funds provides flexibility and convenience.
Interest Charges
If the borrower carries a balance on their revolving credit account, they will be charged interest. The interest rate on revolving credit is typically higher compared to traditional installment loans. This is because revolving credit offers more flexibility and convenience.
Types of Revolving Credit
The most common type of revolving credit is a credit card. Credit cards allow borrowers to make purchases, repay the balance, and use the credit again. Other examples of revolving credit include:
- Lines of credit: These are unsecured loans that provide borrowers with access to a specific amount of funds.
- Home equity lines of credit (HELOCs): These are secured loans that use the borrower’s home equity as collateral.
Credit Utilization and Impact on Credit Score
Revolving credit can have a significant impact on a borrower’s credit score. One of the key factors in credit scoring is credit utilization ratio, which is the proportion of the borrower’s balance to their available credit.
It is recommended to keep the credit utilization ratio below 30% to maintain a good credit score. High credit utilization can indicate to lenders that the borrower may be overextending themselves financially.
Sources
FAQs
What is a revolving credit card?
**Answer:** A revolving credit card is a type of credit card that allows you to borrow money up to a preset credit limit and repay the balance over time. You can use the card to make purchases, and as you repay the balance, your available credit is replenished.
How does a revolving credit card work?
**Answer:** When you use a revolving credit card, you are essentially borrowing money from the credit card company. You can borrow up to your credit limit, and you are charged interest on the outstanding balance. You can make payments on your balance at any time, and as you do, your available credit will increase.
What is the difference between a revolving credit card and an installment loan?
**Answer:** Revolving credit cards and installment loans are both types of credit, but they have different repayment structures. With a revolving credit card, you can borrow and repay money as needed, up to your credit limit. With an installment loan, you borrow a fixed amount of money and repay it in fixed monthly payments over a set period of time.
What are the advantages of using a revolving credit card?
**Answer:** Revolving credit cards offer several advantages, including:
* **Convenience:** You can use your credit card to make purchases anywhere that accepts credit cards.
* **Flexibility:** You can borrow and repay money as needed, up to your credit limit.
* **Rewards:** Many credit cards offer rewards, such as cash back, points, or miles, for using the card.
What are the disadvantages of using a revolving credit card?
**Answer:** Revolving credit cards also have some disadvantages, including:
* **Interest charges:** You will be charged interest on the outstanding balance on your credit card.
* **Fees:** Some credit cards charge fees, such as annual fees, balance transfer fees, and cash advance fees.
* **Impact on credit score:** Using a revolving credit card can impact your credit score. If you carry a high balance or make late payments, your credit score could be negatively affected.
How can I use a revolving credit card responsibly?
**Answer:** To use a revolving credit card responsibly, you should:
* **Pay your balance in full each month:** This will help you avoid paying interest charges.
* **Keep your credit utilization ratio low:** Your credit utilization ratio is the amount of credit you are using compared to your total available credit. Keeping your credit utilization ratio low will help you maintain a good credit score.
* **Avoid cash advances:** Cash advances on credit cards typically have high fees and interest rates.
What should I do if I am having trouble paying my revolving credit card debt?
**Answer:** If you are having trouble paying your revolving credit card debt, you should contact your credit card company. They may be able to offer you a payment plan or other options to help you get back on track.
What are some alternatives to revolving credit cards?
**Answer:** There are several alternatives to revolving credit cards, including:
* **Installment loans:** Installment loans are a good option if you need to borrow a fixed amount of money and repay it over a set period of time.
* **Personal loans:** Personal loans are similar to installment loans, but they are typically unsecured, which means you do not need to provide collateral.
* **Home equity loans:** Home equity loans are secured loans that use your home equity as collateral.