What is Revolving Credit and is it Good to Use?
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There’s a good chance you already have access to revolving credit and use it frequently. Almost 70% of Americans have at least one credit card. Many people have multiple revolving credit accounts or “lines” of credit.
Credit cards (including store credit cards), home equity lines of credit (HELOC’s), and deposit accounts with overdraft protection are examples of revolving credit accounts.
Is revolving credit good to use?
Read on to learn more about revolving credit, how it is different than other loans, and why it may – or may not be a wise decision for you to use it.
How Does Revolving Credit Work?
Revolving credit is flexible financing where a lender extends a set amount of credit. You decide the amount you want to use and when you want to use it.
At the end of the month, you pay the money back or pay interest on any balance remaining (unless you are in 0% interest promotional period).
There are no fixed payments on revolving credit lines. The credit available and your minimum payment fluctuate based on use and repayments to the credit line.
The full balance of your account can be paid early without penalty. You can also use your available credit balance over again until your revolving credit agreement with the lender expires.
Is Revolving Credit Different Than An Installment Loan?
If you have a mortgage, car loan, home equity loan, or a student loan, you have an installment loan.
The original loan is for a set amount that's similar to a revolving credit line. But when you take out an installment loan, you get all of the cash up front to pay for the goods or services.
You then pay the installment loan back with interest until the debt is gone. These types of debt are usually amortized for a set period of years and have a fixed repayment schedule. You don’t get to “re-borrow” the money you pay back on an installment loan.
What are the Advantages of Revolving Credit?
The best things about revolving credit are its flexibility and easy way to pay for things. You get to borrow money quickly in amounts you need without having to reapply to use the credit again.
Payments are also flexible, as long as you make the required minimum payment on time. If you can’t pay the account off each month, you only pay interest on the balance remaining.
Revolving credit doesn’t have to be used on a specific purchase or at a set time. You can keep your credit line open without using it according to the terms of your lender’s agreement.
Some revolving credit comes with the option to earn cashback or other rewards.
Rewards are redeemed for gift cards or travel when you make payments on your account. But this is only a benefit if you pay the full balance on your account each month.
Paying interest on a revolving credit card account or incurring other fees negates any reward value you earn.
Using revolving credit accounts will impact your credit score. Making payments on time and keeping the utilization of your available credit as low as possible boosts credit scores.
A high credit score can get you lower interest rates on installment loans, savings on utilities, and better chances of getting approval on rental agreements.
Are There Drawbacks?
Revolving credit is easy and convenient for consumers to use. But it’s clearly a case where too much of a good thing can create serious financial problems.
Experian reported the average credit card balance was over $4,000 in the third quarter of 2018. And this is only one type of revolving credit people use. In addition, many people with revolving credit also have installment loans they are paying back.
Revolving credit lines usually come with higher interest rates than installment loans too. The average credit card APR is near 17% at this time.
Average variable HELOC rates are lower (about 5.6%) because they are secured with one of your most precious assets – your home. And you may have to pay hefty fees to get this type of revolving credit too.
Some people offered a significant amount of revolving credit, spend more than they originally planned on individual purchases. The more you spend on a revolving credit account, the higher your utilization of available credit.
If you can’t pay a large balance back quickly, your credit score may go down, and you’ll pay a lot more in interest too.
Also, if you close one or more revolving credit accounts too soon, your credit score might go down. This is because the average length of time of established accounts could be reduced. Longer credit history is one of the factors that can raise your credit score.
You can (and should) check your credit history by ordering your free credit report. This article tells you how to obtain your credit report, and then how to read and understand it.
Should I Use Revolving Credit?
Revolving credit has many advantages for people and businesses who need to borrow money. But it’s important to consider your full financial situation and your ability to repay all of your debt.
If you can repay the balance each month or pay as little interest as possible on what you spend, using revolving credit can make sense.
If you can’t pay the balance off promptly or if you are using a revolving credit account as an emergency fund, you might think again. In a crisis, avoiding more payments and high interest rates is probably a better plan.
Finally, make sure you read the fine print if you choose to open revolving credit accounts.
A 90-day interest-free period or two-years of interest-free payments might sound great when you make a purchase. But many people get caught paying back interest when they don’t meet the terms of an agreement.
Use revolving credit wisely to get the benefits of flexible spending and payments while not going deep into debt or hurting your credit score!
Written by Women Who Money Cofounders Vicki Cook and Amy Blacklock.
Amy and Vicki are the coauthors of Estate Planning 101, From Avoiding Probate and Assessing Assets to Establishing Directives and Understanding Taxes, Your Essential Primer to Estate Planning, from Adams Media.