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. After all, managing your finances is a huge part of your livelihood, so you’ll want to make sure you understand the ins and outs.
One of the most important financial terms to understand is the concept of revolving credit. Why is it so important? Well, whether it’s something you’re already familiar with, or you’re left scratching your head when people talk about it, you might be surprised to find that you actually know more about it than you initially thought. That’s because there’s a good chance it already plays a role in your everyday life.
If you’ve ever used a credit card or a personal 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. In this article, we’re going to give you a simple definition of revolving credit, go over some common revolving credit examples, and then discuss some 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 at one time. What this means is that when you draw funds from this revolving credit account, that amount will be subtracted from your total credit limit. Your available credit will then be however much is left over. So, 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.
Revolving credit can also be referred to as open-end credit. This means that unlike an installment loan where your loan will be considered closed once you’ve paid it back in full, open-end credit typically doesn’t have an end date. If you keep your revolving credit account in good standing and don’t actively close it, it may generally be available to you.
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 to make sure you’re getting the most out of what may be available to you. Here are three common revolving credit examples.
1. Credit Cards
This is probably the most common type of revolving credit account, and also the one you may most likely have. Credit cards are generally intended for everyday purchases and will often 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 for you to adhere to, 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 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 previous two entries 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 applies. A HELOC falls into this category. In this case, the collateral you’re providing is the equity that you have in your home. Otherwise, it functions 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.
Generally, HELOCs may be used to help with home improvement projects. If you’re doing a substantial renovation on your house but don’t know exactly how much it’ll end up costing you in the end, a HELOC can provide you with the flexibility you need to see it through.
2 Differences Between 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 remains in good standing, you can use an account like your revolving line of credit multiple times. This can provide you with an added level of flexibility. Unlike an installment loan, you can draw upon your revolving credit account when you need it, and you aren’t tethered to whatever amount a financial institution offers you. If you only need $50, you can choose to draw that amount as long as you have available credit.
With any type of loan that isn’t revolving (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. This could be for things like mortgages, auto loans, or student loans.
2. Your Payments
With installment loans, your payments will be scheduled at equal intervals and will generally be the same amount each time. They’re usually scheduled over a period of months or even years. Having all your payments laid out in front of you may make it easy for you to plan ahead and fit them into your budget.
Keep in mind that depending on the financial institution you’re working with, you may be charged an added fee for paying your loan back early (or late for that matter). However, not all institutions will charge an early repayment fee, so make sure to read your loan agreement closely.
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.
Improve Your Financial Literacy
Working your way through the ins and outs of important financial terminology can be complicated at the best of times. There are all sorts of different terms and products out there, and it can make your head spin if you’re new to this world. But your finances are a hugely important part of your life, and if used properly, different financial products can be used to facilitate all sorts of important steps forward. They can also help handle sticky financial situations.
Revolving credit might be one of those terms that has always confused you but has been right under your nose the whole time! Understanding the different types of revolving credit out there, their specific features, and the differences between them and other types of loans is key to your ability to get the most out of them. We hope this article has helped improve your understanding!
Do you feel like your knowledge of important financial concepts may be lacking in other areas too? At CreditFresh, we always want to emphasize the importance of financial literacy, that’s why we continue to deliver new content on our blog to bring useful personal finance-related information to the public! Click here to visit our blog and learn more.