What is revolving credit and how does it work?
Revolving credit is also known as open-ended credit. Common examples include credit cards, personal lines of credit and home equity lines of credit (HELOCs).
Revolving credit can offer more flexibility than some other borrowing options because it lets people borrow up to a certain amount of money, pay down the balance and then borrow again when needed. Borrowers can typically do this repeatedly as long as the account remains open and in good standing.
Unlike installment loans, which are typically paid on a regular schedule until the loan is repaid, revolving credit has no fixed term, and interest is typically charged on the borrowed amount, not the total available credit.
What you’ll learn:
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When you borrow from a revolving account, your amount of available credit goes down.
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As you repay what you borrow from a revolving account, your available credit increases.
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Common types of revolving credit are credit cards, personal lines of credit (PLOCs) and HELOCs.
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When used responsibly, revolving credit sources like credit cards can help you build a solid credit history.
How does revolving credit work?
Revolving credit accounts, such as credit cards, can be a powerful tool for building credit—if you know how they work. Understanding how things like credit limits, available credit, repayment and balances affect your account can help you use credit responsibly and make it work in your favor.
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Credit limit: Revolving credit accounts typically come with a preset credit limit. This limit is the maximum amount account holders are allowed to charge to the account.
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Available credit: The amount of available credit decreases as you use the card. If a credit card has a $5,000 limit and the cardholder charges $800 to the card in one month, they can expect their available credit to drop to $4,200.
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Repayment: As balances are repaid, the available credit typically increases by a corresponding amount. So if the cardholder from the above example paid off their monthly statement balance, they could expect their available credit to be restored to $5,000.
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Balance: A revolving credit balance can be paid back all at once or in increments. But consistently making at least the minimum payment on time is a large part of keeping your account in good standing and avoiding late fees. When it comes to credit cards, if you’re able to pay off your statement balance on time each month (instead of just minimum payments), you can typically avoid interest on new purchases.
Secured vs. unsecured revolving lines of credit
Revolving credit can come in two types: secured or unsecured. Secured accounts use collateral to help you qualify. Unsecured accounts, such as most credit cards, don’t require any collateral and rely only on creditworthiness.
Revolving credit examples
Revolving credit comes in several forms. Understanding the options can help you choose the right tool for building your credit. While these accounts all let you borrow, repay and borrow again up to a set limit, each type works a little differently depending on your needs and financial goals. Here are some common examples:
- Credit cards: Credit cards let you make purchases up to a set credit limit and repay the balance over time, either in full or through monthly payments. They’re a common revolving credit tool and can help you build credit when used responsibly.
- Personal lines of credit: A PLOC, for short, is similar to a credit card. But it’s not linked to a physical card. Instead, you receive funds you can repeatedly borrow and pay back up to a certain limit.
- Home equity lines of credit: A HELOC, for short, lets you borrow money against the value of your home. You can borrow and repay the money multiple times against a preset credit limit. This is different from a home equity loan, which is a lump sum of money you borrow once with a fixed interest rate.
How does revolving credit hurt or help credit scores?
Like other types of credit accounts, the way a revolving account impacts your credit scores depends on how you manage your account. Some of the factors used to calculate credit scores include:
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Payment history
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Debt
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Credit age
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Credit mix
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New credit applications
If you fall behind in your payments for your revolving credit account or max out your spending, your credit score can take a hit. But if you consistently make payments on time and keep your credit utilization ratio low, you can use a revolving credit account to improve your credit scores over time.
Installment loans vs. revolving credit
Installment loans let you borrow a set amount of money and repay it over a fixed schedule, typically with equal monthly payments. They’re also called non-revolving or closed-ended accounts.
Common examples include auto loans, student loans, mortgages and personal loans. Here are some ways installment loans are different from revolving credit:
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Available credit: With closed-ended installment loans, you borrow the full amount once. The account is closed once your balance is repaid.
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Payments: Installment loan accounts are generally repaid in regular, equal payments—also known as installments—over a specific period of time. And in some cases, there might be a prepayment penalty for paying off the loan ahead of schedule.
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Interest rates: Installment loans may have lower interest rates than revolving credit accounts if they’re backed by collateral. But keep in mind that it might be possible to avoid interest charges on revolving credit if the balance is paid off every month.
- Flexibility: Many installment loans are only approved for a specific purpose, such as a car loan or mortgage.
FAQ: Revolving credit
Some frequently asked questions about revolving credit.
Is revolving credit good or bad?
Any kind of debt can be good or bad, depending on how it’s managed. But revolving credit can be particularly helpful, especially when you have unexpected expenses.
Some revolving credit accounts may also offer cash back or other rewards. And like other types of credit, consistently using revolving credit responsibly could have a positive impact on your credit scores.
What is a good revolving credit limit?
A “good amount” of revolving credit isn’t about hitting a specific dollar figure. It might be better to think about having a credit limit that gives you enough room to keep your balances relatively low compared to what’s available. Lenders generally view it positively when you’re using only a small portion of your total credit limit, because it suggests you’re managing credit responsibly. In many cases, having more available credit could make it easier to keep your balances low relative to your limit.
Part of your credit scores depend on how much credit you have versus how much you’ve used. This is called your credit utilization ratio. While everyone’s situation is different, the Consumer Financial Protection Bureau (CFPB) recommends using no more than 30% of your available credit.
When should you use revolving credit?
Ultimately, when to use revolving credit is up to the borrower. Revolving credit can be a flexible way to make purchases and repay them over time. In contrast, installment loans are often reserved for larger, dedicated expenses such as cars or homes.
Should I pay off my revolving credit balance?
The CFPB recommends paying off your entire balance whenever possible—or at least the minimum each month—because missed payments can result in fees and can negatively impact your credit scores.
Key takeaways: Revolving credit
Using revolving credit can give you convenient access to funds whenever you need them, as long as you stay within your credit limit. And when you manage these accounts consistently and responsibly, they may even help strengthen your credit scores over time.
Thinking about opening a revolving credit account? You can compare Capital One credit cards and see whether you’re pre-approved, with no impact to your credit scores.
