When it comes to personal loans, navigating the different terms and financial lingo can make your head spin if it’s not something you’re familiar with. And when it comes to financial products and terms, it’s especially important to understand what you’re talking about.
One of the most important financial terms to understand is the concept of revolving credit. If you’ve ever used a credit card or a revolving line of credit, you likely have some idea of how it works. But because of how important it is, you’ll want to make sure you have a strong understanding of it and what role it can play in your finances. Let’s go over a simple revolving credit definition, look at some common revolving credit examples, and then compare this to other common types of loans as well.
Revolving Credit Definition
One of the main features of revolving credit is that if you’re approved for any sort of revolving credit account, the financial institution that the account is with will give you a credit limit. This limit is the highest amount of money you can draw from that account. What this means is that when you draw funds, that amount will be subtracted from your total credit limit. Your available credit will then be however much is left over.
Credit Limit Example
If your credit limit is $1,000 and you draw $200, you’ll have $800 left. As you pay what you’ve drawn along with any associated interest and/or fees, you’ll keep replenishing your available credit.
If you keep your revolving credit account in good standing and don’t actively close it, it may generally be available to you when you need it.
Revolving Credit Examples
Like we mentioned, there are a few different types of accounts that fall under the revolving credit umbrella. They all have different uses, so it’s important to have an understanding of what each is for. Here are three common revolving credit options.
1. Credit Cards
This is probably the most common type of revolving credit account, and also the one you probably already have. Credit cards are generally intended for everyday purchases and will usually come with rewards for you to take advantage of. These could be cashback dollars, travel rewards, and more.
Generally speaking, the payment activity on your credit card is reported to a credit bureau. This means that they can have an impact on your credit history. That’s why you’re going to want to make sure you make all your payments on time, which is true of any revolving credit account (or any bill for that matter).
2. Personal Revolving Line of Credit
There are a lot of similarities between credit cards and personal lines of credit. They’re both revolving credit accounts that come with credit limits, and they can both be used for everyday purchases (depending on the type of line of credit).
One of the main differences is that your revolving line of credit generally can’t be accessed with a physical card. Instead, you’ll typically request a draw from the financial institution and funds will then be deposited into your bank account. The amount of time it takes for your request to be processed will depend on the financial institution as well as your bank.
3. Home Equity Line of Credit (HELOC)
The first two examples on this list often fall into the category of unsecured loans. This means that you don’t need to provide any collateral to qualify. With a secured loan, the opposite is true. A revolving home equity line of credit (HELOC) falls into this category.
In this case, the collateral you’re providing is the equity that you have in your home. Otherwise, it works similarly to other forms of revolving credit in that you’ll be given a credit limit that you can use on a revolving basis. This is different from a home equity loan, where you’ll still be using equity as collateral, but will be given a lump sum instead.
One important distinction to make for HELOCs is that they’re split into two periods: a draw period and a repayment period. During the draw period, you can borrow from your line of credit, and you’ll only need to pay interest on what you borrow.
Once the draw period is finished (it can last up to 10 years) you’ll enter the repayment period. During this phase, you won’t be able to draw funds, and you’ll start to pay off the principal balance on top of the interest you need to pay. This period can be up to 20 years long.
Want to learn more about the differences between secured and unsecured loans? Click here!
Installment Loans vs. Revolving Credit
Like we mentioned previously, one of the main features of revolving credit is that it can be used on a recurring basis. This distinguishes it from another common category of loans: installment loans. Let’s take a closer look at a couple more key differences.
1. Open-End vs. Closed-End Loans
As long as you have available credit and your account is in good standing, you can use an account like your revolving credit line multiple times. This can give you some extra financial flexibility. Unlike an installment loan, you can use your revolving credit account when you need it, and you can draw as much or as little as you need as long is it’s within your credit limit and you have available credit.
With any type of loan that isn’t revolving credit (closed-end loan), you can only use it once without having to apply for a new loan. For example, if you’re approved for an installment loan, you’ll receive a lump sum of cash which you’ll then pay back over the course of several months or years, depending on the type of loan.
2. Your Payments
With installment loans, your payments will be scheduled at equal intervals and will generally be the same amount each time. With revolving credit, your payments will change based on how much of your available credit you’ve drawn. This also means that your minimum payment can change from one payment cycle to the next.
If you’re interested in learning more about how a Line of Credit through CreditFresh works, our How it Works page breaks it down for you!
Improve Your Financial Literacy
Understanding what revolving credit means and how it works can help you make more informed financial decisions. We hope these revolving credit tips have helped improve your understanding!
Disclaimer: The information contained within this article, including any references to companies or products, are for informational and educational purposes only and are not a substitute for individualized financial and/or legal advice. We are not a credit repair organization as defined under federal or state law and we do not provide "credit repair" services or advice or assistance regarding "rebuilding" or "improving" your credit. We make no representation that we will improve or attempt to improve your credit record, history, or rating through the use of the resources provided through the FreshStart Blog or CreditFresh website. The views and opinions expressed by any guest contributors, as applicable, are solely those of the author and do not reflect the views of CreditFresh.
