What is Revolving Credit?

There are quite a few different types of credit available to the average U.S. consumer, but the most common type is in the form of revolving credit. Revolving credit can be very helpful, but at the same time, it can be financially destructive if you do not manage it correctly.

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Every Day Revolving Credit Types

The simplest form of revolving credit would be a credit card. As you probably know, a credit card has a spending limit attached to it; a certain amount of money that you have access to at all times. Whether you choose to use it or not is your prerogative, but once you do, you begin to pay interest on any principal that is not paid off by the end of the month. Essentially, the easiest way to think about revolving credit would be access to funding that has a set balance the can be accessed. The amount owed can go up or down depending on how often the client uses it and it is a type of credit that does not have a fixed number of payments.

There are also other types of revolving credit, such as an equity line of credit. Homeowners will apply for a home equity line of credit (HELOC), and then have the ability to borrow money up to that limit at any time, recognizing that as soon as they do, they are in fact putting their house up as collateral. It is typically a percentage of the equity of the house, free and clear of any outstanding balance on the mortgage. This revolving credit tends to be much larger than the limit on credit cards, but it comes with the added risk of perhaps losing your home if you do not pay the money back.

Understanding Revolving Credit

While a home equity line of credit can be helpful, unfortunately, some people might use the money to pay for a vacation or to purchase the latest gadget, instead of simply not accessing the funds at all or using them to do things that are much more prudent, such as replacing the roof on their home, or perhaps paying an electrician for a necessary repair.

Some credit card holders are also guilty of spending money right up to the spending limit, not considering that this money not only needs to be paid back, but the interest is also higher if they miss these payments.

Interest Rates are Higher

Unfortunately, most revolving credit loans have higher interest rates. For example, it’s not uncommon for credit card interest rates to fall between 9-25%. This is because the revolving credit line is much more flexible and therefore the lender takes on quite a bit of risk.

You should also keep in mind that revolving credit can have an impact on your credit score. Having a high credit card balance over the long term, could reflect a spending problem. Missing payments on a revolving credit loan, such as a credit card, can have a detrimental effect on your credit report, perhaps damaging your ability to borrow money for other purchases down the road, such as a vehicle or home. For example, just one payment made 30 days late could knock your credit score down by as much as 100 points, according to Equifax, one of the three major credit reporting bureaus.

Use Revolving Credit Appropriately

Although revolving credit does carry its own risks, paying off any balance by the end of the month shows the responsible use of credit cards and revolving credit, and this can help you establish a responsible credit profile. Beyond that, simply making your payments on time and not overburdening yourself with this type of debt, can do the same.

One should also keep in mind that revolving credit is something that you should use sparingly, and perhaps as an emergency fund, more than anything else. For example, if you get a sudden large car repair bill, a credit card can help you in your time of need, but if you are simply looking to buy the latest iPhone but don’t really need it, you are probably making a financial mistake.

Final Thoughts

Like all credit, it comes down to responsible use. If you use it irresponsibly, you will pay for it down the road. Keep in mind that the interest rates with revolving credit are notoriously higher, so unless you can pay off the balance by the next billing cycle, you are going to pay more for those purchases. The longer time goes on, the more you pay in extra fees and interest.

By simply using revolving credit responsibly, you can have that added financial security when it’s needed the most. Maxing out your credit cards and home equity line of credit are two of the most destructive things you can do to your financial situation. By all means, you should have the tools of revolving credit at your disposal, but only if used appropriately.