- Revolving credit refers to accounts that let you buy on credit or borrow repeatedly up to a certain amount.
- Credit cards, retail cards and lines of credit are common types of revolving credit.
- Depending on how you manage your balances, revolving credit can have positive or negative effects on credit scores.
You may have heard the term “revolving credit,” but are not sure exactly what it refers to — or how it can affect your credit score. In fact, you may be using a form of revolving credit every day without much thought, which is why it’s important to know how it works and how to use it wisely.
What is Revolving Credit?
Revolving credit is a type of credit account that lets you repeatedly borrow money up to a certain limit to use as you need. At the end of each billing cycle, you can either pay the balance in full or “revolve” a balance — carrying a portion of it over to the next month and borrowing that unpaid amount.
What are Some Revolving Credit Examples?
Credit cards, retail cards and lines of credit are common types of revolving credit.
Credit cards are an indispensable way to pay for everyday purchases — large or small — so they are the best-known type of revolving credit. With credit cards, your purchases are billed monthly and you can either pay the minimum amount due, the full balance or something in between. Credit card issuers charge interest on the unpaid (or revolving) balance and may offer perks to cardholders like rewards or cash back based on what you spend.
Retail cards are simply credit cards issued by certain retailers to be used only for purchases at specific stores or related retailers. Since retail cards can’t be used anywhere else, they may only make sense if you’re using them to make purchases at stores where you shop frequently. Just like with major credit card accounts, you can pay the monthly balance in full or in part. You’ll be charged interest on outstanding balances, and some retailers may offer cardholders limited discounts or perks for their brand loyalty.
Lines of credit
Lines of credit function like a mix of loans and credit cards. A home equity line of credit (HELOC), for example, taps the available equity in your home as a revolving credit line to use for large expenses. As homeowners repay their outstanding balance, the amount of available credit is restocked — similar to a credit card. You can continue to draw from the line up to the term and credit agreement you establish with the lender.
A personal line of credit is another flexible form of revolving credit that requires no collateral — unlike the HELOC, which is secured by your home. A personal line of credit sets a maximum credit limit that you can tap as needed over a defined period of time. What you withdraw gets subtracted from the overall credit limit, and you only pay interest on the amount of credit you use.
How Does Revolving Credit Work?
Revolving credit allows you to repeatedly borrow money as long as you stay within your credit limit. When you’re approved for a revolving credit account, the issuer or lender will set a maximum amount that you can charge or draw from.
Revolving credit accounts are open-ended, which means as long as the account remains open and in good standing, you can continue to use it — without having to reapply or go through a new credit check.
When you make a purchase on a credit card, for instance, you’ll have less available credit. Every time you make monthly payments, your available credit goes back up. If you don’t pay the full balance on your revolving credit account every month, the unpaid amount carries over to the next billing cycle, and interest is charged on the amount you owe at that time.
How Do Revolving Credit Accounts Affect Your Credit Score?
Revolving credit is one way to build or improve your credit score because handling revolving credit well can be a good indicator of reduced credit risk. But just like all types of credit, revolving credit can also harm a credit score if ill-managed. Here are a few important factors that can have positive or negative effects on your credit score.
Credit scoring considers your credit utilization rate, which is the amount of revolving credit you use compared to your total credit limit. You can figure this percentage by dividing your outstanding balance by your credit limit.
Reducing your credit utilization ratio can benefit your credit report in two ways: It gives you greater flexibility to access available credit when you need it, and it can indicate to lenders that you have the ability to meet your financial obligations without overextending your credit.
Because revolving credit accounts aren’t closed after a set number of payments like installment loan accounts, you can keep them open indefinitely. This allows you to build up a stable history of managing credit accounts over time — and a longer credit history will always have a positive effect on your credit score.
Opening and closing a revolving line of credit
It may seem like a no-brainer to close out an old revolving credit account that’s either paid up or no longer used. But it’s hard to know exactly what effect it will have on your credit score. That’s because there are two main credit-score factors that may be impacted when a revolving credit account is closed: credit utilization and credit age.
In addition, credit scores consider the age of your oldest account, the age of your newest account, and the average age of all open accounts. Closing a new account and increasing these ages may help your credit – while closing an old account that decreases any of these measures may hurt your credit.
By keeping a credit card account open, you may benefit from having a longer credit history and a lower credit utilization rate. You may also avoid getting a temporary ding to your credit score.
How to Best Manage Revolving Credit
Here are a few tips you’ll want to follow to make sure that revolving credit works toward your personal finance goals — and not against them.
Because it can be used multiple times, a revolving credit account has a greater risk of increasing debt. Always keep track of what you already owe when you think about spending more.
Pay your balance in full each month if possible
Paying off a revolving balance in full is the best way to avoid accruing interest charges and preserve your credit limit in case you need it for a future expense.
Pay more than the minimum payment
When thinking about repayment, paying more than the minimum amount of money due is a smart way to trim your balance quickly and reduce the amount of interest you’ll be charged. Keep this tip in mind as your balance drops and the minimum payment amount is smaller, it’s easy to be tempted to reduce your payment amount as well.
Make payments on time
It’s important to meet payment due dates on revolving credit accounts. Your payment history is the single biggest factor in calculating your FICO credit score. As far as payment history goes, one year of on-time payments without being past due is good, and two years or more is even better.
Prioritize higher interest accounts first
Making payments toward accounts that charge a higher interest rate is a good strategy for saving money, because those balances are the ones that will ultimately cost you the most money in the long run.
Use Revolving Credit Wisely
Revolving credit is a common way for lenders to issue funds. Understanding how it works and using it as a financial tool can help you build credit and maximize your credit score.
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