Credit cards and a home equity line of credit (HELOC) are the most common types of revolving credit. Keep reading to learn more about how revolving credit works, how it can affect your credit score and the difference between a revolving and non-revolving line of credit.
Definition and Example of a Revolving Line of Credit
A revolving line of credit is a preapproved loan or credit line that lets consumers and businesses borrow and repay money on a regular basis. It comes with an annual percentage rate (APR), credit limit, and monthly payments. Borrowers can use it as much or as little as they want as long as the account is open, they make the monthly payments and do not exceed the credit limit. Revolving credit is most common with credit cards, a home equity line of credit, and a personal line of credit.
Alternate name: Revolving credit.
Credit card accounts are the most common example of a revolving line of credit. There’s a set limit, APR, and monthly payments after you open an account. You can use your card for a variety of purchases. As you spend, your available credit decreases. Once you make a payment, that amount becomes available to borrow against again.
How Does a Revolving Line of Credit Work?
A borrower must first be approved for a revolving line of credit. Once they’re approved, the lender will set a maximum limit for the line of credit based on the borrower’s credit score, credit history, and income. The borrower can use the total amount available at once or spend as needed. At the end of each billing cycle, the borrower will receive a billing statement with a required minimum payment. The borrower only has to pay against the amount they borrowed, not the full credit available. They can choose to pay off the entire statement balance, another amount, or the minimum payment. Once a payment is made, that amount becomes available to borrow again, hence the term revolving credit. Any balance carried over to the next billing cycle will likely be subject to fees, including interest. Borrowers won’t be charged any interest if they pay off the entire balance by the statement due date. They are not required to use the entire credit limit available and should only spend what is needed. Consumers who use credit cards are utilizing a revolving line of credit. For example, let’s say you apply and are approved for a credit card with a $5,000 limit. You can use it at your discretion and spend whatever you want as long as you make your required minimum monthly payments and don’t go over the limit. During the first month, you spend $500. That leaves you with $4,500 in available credit. When the monthly billing statement comes, you can pay the minimum payment, the full $500 balance, or another amount by the payment due date. You decide to pay $200, which increases your revolving credit available ($4,500 + $200) to $4,700. The remaining balance, $300, is carried over to the next billing cycle and will begin accruing interest until it is paid. Carrying over a balance on a revolving line of credit can impact your credit score. Credit reporting agencies factor in your credit utilization ratio— the total amount of credit you’re using versus the amount you have available—to your total credit score. A utilization ratio of over 30% can lower your credit score. Keeping a low revolving balance or paying it off every month is the best way to keep it from negatively affecting your credit score.
Types of Revolving Lines of Credit
The three most common examples of revolving lines of credit are credit cards, personal lines of credit, and home equity lines of credit.
Credit Cards
The majority of credit cards offer a revolving credit line. It allows borrowers to utilize available credit repeatedly on everyday goods and services. Each line of credit has a maximum limit, interest rate, and monthly payments.
Personal Line of Credit
A personal line of credit is an unsecured loan through a bank or credit union. Instead of a card, borrowers use special checks or electronic transfers deposited into their bank account to access funds. Similar to a credit card, a personal line of credit has a credit limit, monthly payment, APR and a potential fee when you use the account.
Home Equity Line of Credit (HELOC)
Homeowners may use a HELOC to borrow money against the equity in their home. This open-ended line of credit allows homeowners to borrow and repay money repeatedly. A HELOC usually has a fixed amount of time borrowers can withdraw money before a final repayment period. HELOCs typically have a variable interest rate, monthly payments, and a credit limit. A decrease in home value could affect the revolving credit limit.
