What Is Revolving Credit and How Does It Work?
Learn more about revolving balances, credit utilization and interest
Wondering about revolving credit? You might actually be more familiar with it than you think. Revolving credit refers to an open-ended credit account—like a credit card or other “line of credit”—that can be used and paid down repeatedly as long as the account remains open.
Still have questions? Keep reading to learn more about how revolving credit works, what a revolving balance is and how to stay in control of your accounts.
How Does Revolving Credit Work?
If you’re approved for a revolving credit account, like a credit card, the lender will set a credit limit. The credit limit is the maximum amount you can charge to that account. When you make a purchase, you’ll have less available credit. And every time you make a payment, your available credit goes back up.
Revolving credit accounts are open ended, meaning they don’t have an end date. As long as the account remains open and in good standing, you can continue to use it. Keep in mind that your minimum payment might vary from month to month because it’s often calculated based on how much you owe at that time.
What Is a Revolving Balance?
If you don’t pay the balance on your revolving credit account in full every month, the unpaid portion carries over to the next month. That’s called a revolving balance.
You might apply for credit assuming you’ll always pay your balance in full every month. But real life can get in the way. Cars break down. Doctors’ appointments come up. And if you can’t pay your full balance, you’ll find yourself carrying a revolving balance to the following month.
What About Revolving Balances and Interest?
As the Consumer Financial Protection Bureau (CFPB) explains, “A credit card’s interest rate is the price you pay for borrowing money.” And the higher your revolving balance, the more interest you might be charged. But you can typically avoid interest charges by paying your balance in full every month.
What’s Revolving Utilization and How Does It Impact Credit Score?
Your credit utilization ratio—sometimes called revolving utilization—is how much available credit you have compared with the amount of credit you’re using. According to the CFPB, you can calculate your credit utilization ratio by dividing your total balances across all of your accounts by your total credit limit.
So why does your credit utilization ratio matter? It’s one of the factors that determines your credit score. If you manage credit responsibly and keep your utilization ratio relatively low, it might help you improve your credit score. The CFPB recommends keeping your utilization below 30% of your available credit.
Types of Revolving Credit Accounts
Credit cards, personal lines of credit and home equity lines of credit are some common examples of revolving credit accounts.
- Credit cards: Many people use credit cards to make everyday purchases or pay for unexpected expenses. Some credit cards come with rewards and benefits you can use to your advantage.
- Personal line of credit: A personal line of credit is similar to a credit card. But it’s not linked to a physical card. Instead, you might get the funds in the form of a check or a direct deposit into your bank account.
- Home equity line of credit: According to the CFPB, a home equity line of credit (HELOC) is an open-ended credit account that lets you borrow money against the value of your home. And since it’s open ended, you can borrow and repay the money multiple times as long as you don’t exceed the credit limit. It’s important to note that a HELOC is different from a home equity loan, which is typically a lump sum of money with a fixed interest rate that you borrow once.
What’s the Difference Between Revolving and Nonrevolving Credit?
The major difference between revolving and nonrevolving credit is whether the credit account can be used on a recurring basis. But there are a few other differences that you should be aware of, too.
- Open ended vs. closed ended: With revolving credit, you can use the line of credit repeatedly—up to a certain credit limit—for as long as the account is open. But with nonrevolving credit, you can borrow the amount only once. And the account is closed permanently after it’s paid off. Nonrevolving credit is also known as installment credit. Some common types of installment credit include auto loans, mortgage loans and student loans.
- Interest rates: Revolving credit might also have a higher interest rate than nonrevolving credit has. And with revolving credit, your minimum payment might change depending on your balance. With nonrevolving credit, you’ll likely owe the same amount each billing cycle.
- Payments: Nonrevolving credit accounts are generally repaid in regular, equal payments—or installments—over a specific period of time. And in some cases, there might be a penalty for paying off the loan ahead of schedule.
- Flexibility: Revolving credit might give you more flexibility, too. A credit card, for example, can be used for a wide variety of purchases. But many nonrevolving credit agreements are for one specific purpose, like buying a car or a house.
The specifics of how your revolving or nonrevolving credit account works can vary. And it’s always a good idea to make sure you understand the terms of any credit agreement you enter into.
How to Stay in Control of Revolving Credit
A few simple steps can help you pay down a revolving balance and might even help your credit score moving forward.
- Spend responsibly. This is a good tip whether you carry a revolving balance or not. But if you do have a balance, make sure to keep in mind what you already owe when you think about spending more.
- Pay more than the minimum. Whenever possible, pay more than the minimum amount due. It might help you lower your balance more quickly.
- Consider paying off higher interest accounts first. Because these debts are costing you the most money, it might be a good idea to increase your payments to your higher interest accounts.
- Make all payments on time. By steering clear of late payments, you can avoid late fees. And you might even be able to help boost your credit score by consistently making on-time payments.
- Monitor your credit score. Did you know you’re entitled to free credit reports from each of the major credit bureaus? Learn how to get free copies of your credit reports from AnnualCreditReport.com.
You can also monitor your credit score with CreditWise from Capital One. CreditWise is free for everyone and alerts you when something meaningful changes on your TransUnion® and Experian® credit reports. You can access your report and weekly VantageScore® 3.0 credit score anytime, without negatively impacting your score.
Now you know more about how revolving credit works and how to manage it responsibly. And you might even be able to use your revolving credit accounts to improve your credit score, establish a credit history and build a brighter financial future.
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