Revolving Credit: What It Is and How It Works

Revolving credit lets you borrow money as needed up to an available credit limit or line and only pay interest on the money you use. It lets you access funds to finance purchases or for emergencies. Common types of revolving credit include credit cards, lines of credit (LOC), and home equity lines of credit (HELOC).

What Is Revolving Credit?

Revolving credit is a type of credit a lender or creditor extends to you that replenishes itself as you pay down your debt. You can use as much or as little as you need, up to your approved credit limit or credit line. Your monthly payment is based on how much money you borrow. Lenders and creditors may charge you interest depending on how long it takes you to repay your balance.

Having access to revolving credit can be an excellent way to manage your monthly finances or cover unexpected emergencies. However, before applying for revolving credit, it’s crucial to understand the possible fees and interest charges you may be responsible for paying. Such fees include foreign transaction fees, cash advance fees, annual fees, and draw fees.

How Revolving Credit Works

How and when you draw money—such as a transfer to your bank account or as an electronic payment—can differ depending on the type of revolving credit account you open. You’ll need to repay your balance to replenish your available credit. Your payment typically consists of your purchases plus any fees or interest charges.

Important things to keep in mind when considering the use of revolving credit include:

• Drawing money: Depending on the type of revolving account—credit cards, LOCs, or HELOCs—the way you draw money may vary. You can typically draw money through a bank account transfer or an electronic payment. Once you draw against your credit limit or credit line, you will have a balance due on your account.
• Making payments: Similar to how you draw money, your payments differ depending on the type of account. Credit cards typically only require a monthly minimum payment, LOCs require repayment over a set period, and HELOCs require interest-only payments and convert to a term loan on a specific date.
• Fees to watch out for: Be sure you understand the fees that come with using a revolving credit account. For example, revolving accounts may charge annual fees, foreign transaction fees, cash advance fees, origination fees, and closing costs. These fees will vary depending on the type of account and lender or creditor.

Revolving accounts have many moving parts, such as how you draw money, make payments and the fees that your lender or creditor may charge to your account. Knowing these different features can help you use your account responsibly. It’s also vital to know how you can use revolving accounts to your advantage.

What Revolving Credit Is Best For

Revolving accounts can be used for many things, such as covering your typical monthly expenses, for unexpected emergencies, and as flexible funding or spending. It’s a handy way to access necessary funds that you don’t already have as cash on hand.

Revolving credit is best for:

• Covering monthly expenses: You can use revolving accounts to help cover your typical monthly and daily expenses. This is one way you can finance purchases and repay them on time at a later date. Credit cards even offer ongoing rewards that can serve as a discount and help you save on these monthly expenses.
• Unexpected emergencies: Revolving credit is there for when you need to access it and can serve as a rainy day fund. This is an excellent way to protect you from any emergency expenses that you can’t or don’t want to cover with cash on hand.
• Flexible financing and spending: Revolving accounts are flexible because you only have to repay what you use, and you can use as much or as little as you need up to your approved limit. This gives you the option to finance large purchases or have the necessary funds for when you need them.

When you use revolving accounts, be sure you have the funds to repay your balance promptly or to meet the specific spending requirements. Failing to repay on time may result in expensive interest charges or can hurt your personal credit score.

Revolving Credit vs Nonrevolving Credit

When comparing revolving vs nonrevolving credit, the primary difference is you can’t reuse nonrevolving credit. Nonrevolving credit accounts typically include installment loans, such as home mortgages, student loans, and auto loans. When you borrow money through a nonrevolving account, you agree to a fixed repayment schedule and interest rate. You must make monthly payments to meet your loan agreement and repayment terms. Once you pay off your balance, the account is closed.

While a nonrevolving account typically has a lower interest rate and predetermined repayment schedule, it lacks the flexibility revolving accounts offer. Revolving accounts allow you to reuse your approved credit limit as you repay the money you borrow. Be sure to consider the terms and fees for either option and meet the repayment schedule to avoid hurting your personal credit score.

Types of Revolving Credit

Consumers have the option to choose from various types of revolving accounts, depending on their use case. Some of the most common types of revolving accounts are credit cards, personal LOCs, and HELOCs. If you’re a business owner, you also can open a small business credit card or small business LOC.

The most common types of revolving credit are personal and business credit cards and LOCs, small business LOCs, and HELOCs.

Personal Credit Cards

Personal credit cards give you access to an approved credit limit ($500 to $10,000 or more) that you can use repeatedly as long as you repay your balance. Most credit cards require a personal credit score of at least 640. Additionally, they charge annual fees between $0 to $550 and ongoing annual percentage rates (APRs) between 9% and 27%. The best options offer introductory 0% financing on purchases and balance transfers for up to 21 months.

Credit cards are an excellent way to build your personal credit score, earn consumer-driven ongoing rewards, and avoid having to pledge collateral to receive financing. You’ll earn cash back or points-based rewards in categories like groceries, transportation, and United States streaming services. Some options offer possible one-time rewards of up to $500 or more for spending a specific amount in the first several months.

Business Credit Cards

Business credit cards are an excellent way to earn rewards for business-related expenses, build your business credit, and separate your business and personal finances. You can access credit limits from $2,000 to $50,000 or more with no collateral requirement. Small business credit cards typically charge annual fees between $0 and $595 and ongoing APRs between 9% and 25%. We recommend personal credit scores of at least 670 to qualify for the best cards.

Personal Line of Credit

A personal LOC gives you a pre-established credit limit that a lender has agreed to let you borrow and requires no collateral. Personal LOCs can have limits of $1,000 up to $100,000 or more and charge interest rates from 7% to 23% APR. These features typically vary per lender and rely heavily on your personal credit score.

Similar to a credit card, a personal LOC lets you reuse the principal once it’s repaid. You can draw from your line of credit as needed, up to the maximum amount. Each draw is considered a short-term loan that you repay over a specific time period, generally between a couple of months up to several years. You’re only required to make payments on the amount you borrow and lenders only charge interest on those funds.

Lenders typically don’t charge prepayment penalties if you repay your line of credit early. However, some online lenders calculate a prepayment fee instead at the start of the loan. For example, a $10,000 draw may have a six-month repayment term with a total draw fee of $1,000. That $11,000 is owed whether it’s paid in full the next month or six months.

Business Line of Credit

A small business line of credit gives business owners access to funds that they can draw from as needed. Business LOCs typically offer limits from $5,000 up to $250,000. However, this amount is not guaranteed. The typical APR for a business LOC from a traditional bank ranges from 30% to 50%. Similar to personal LOCs, they’re also unsecured—meaning lenders don’t require collateral like inventory or real estate.

Home Equity Line of Credit

A home equity line of credit (HELOC) is a revolving credit line collateralized by your home. HELOCs have a maximum limit based on the amount of equity in your home with combined debt typically not exceeding 85% of your home’s value. Additionally, they charge interest rates as low as 5.25% and closing costs of 2% to 5%. Most lenders also require a down payment of at least 20% to avoid private mortgage insurance (PMI).

You’ll have a five- to 10-year draw period with interest-only payments. After the draw period, the line of credit will be converted into a fixed payment loan amortized over 10 to 20 years. After the conversion, you can no longer make draws and must pay both principal and interest. Interest-only payments are tempting. However, payments may skyrocket when a HELOC converts into a loan, which can leave you in a difficult financial situation.

HELOCs are a good option for homeowners who have a personal credit score of at least 620 and existing equity in their homes. They’re also a solid option for consumers who want access to funds they can repay on their own terms, compared to personal LOCs and installment loans. However, unlike a personal LOC, a HELOC is secured by your home. If you fail to make payments, your home could be at risk.

How Revolving Credit Affects Your Personal Credit Score

When you use revolving credit, it can have an impact on your personal credit score. How you use and manage your credit will determine if it has a positive or negative impact on your credit score. Revolving accounts can impact your payment history, debt levels, the average age of your credit, and your credit mix, which make up your credit score.

Revolving credit can affect your credit score by impacting the five factors of personal credit:

• Payment history (35%): Your payment history makes up 35% of your credit score. Failing to pay your balances on time will damage your personal credit score. Paying on time will help you build a positive credit history and improve your score over time.
• Credit utilization ratio (30%): Consumer credit bureaus look at your debt levels to evaluate how you manage your credit. Your credit utilization ratio is measured by comparing your credit balances to your total credit limits. As a rule of thumb, a ratio of less than 30% is generally considered good.
• Length of credit history (15%): Creditors and lenders like to see a long credit history of using credit responsibly. It’s important to keep old revolving accounts open, such as credit cards, even if you’re not using them anymore. This will increase your credit’s average age and help maintain a high personal credit score.
• New credit (10%): If you open multiple revolving accounts in a short period of time, you’ll look like a risky borrower, and your personal credit score can fall. It’s crucial to reduce the number of inquiries made during a short time period to avoid a negative impact on your credit score.
• Credit mix (10%): Having different types of credit indicates you’re able to manage multiple revolving and nonrevolving accounts responsibly. Provided you pay your debt in a timely manner, your credit mix—revolving accounts and installment loans—can have a positive impact on your credit score.

When you use revolving credit, it’s important to check your personal credit score to know how your credit use impacts your personal credit score. You can check it as often as you’d like because it counts as a soft inquiry, which won’t hurt your credit score. If you’re also a business owner, it’s vital to understand how business revolving accounts like business credit cards or business LOCs can impact your business credit score.

How Revolving Credit Affects Your Business Credit Score

Business revolving accounts can have a negative or positive impact on your business credit score. Each business credit bureau calculates your business credit score differently. However, they generally evaluate your payment history, credit utilization, length of credit history, financial performance, size of your company, and age of your business. Irresponsible use of business revolving accounts can impact your business credit score negatively. However, you can also build good business credit through responsible credit card practices.

Tips for Using Revolving Credit

Revolving credit is an excellent way to manage your expenses before you receive your next paycheck. Additionally, some options, such as credit cards, let you save money through ongoing rewards. However, it’s important to understand best practices to ensure you use revolving credit responsibly, such as maintaining low balances, making timely payments, and planning ahead for future expenses.

When using revolving credit, make sure to:

1. Manage and control your cash flow: Revolving accounts can be there for when you have unexpected expenses, or you haven’t yet received your paycheck. If you use revolving accounts, be sure to borrow only what you need and what you can afford. Using too much credit can lead to excessive debt that is difficult to repay.
2. Maintain low balances: You can use up to your maximum limit on a credit card or other types of credit. However, that doesn’t always mean you should. When you maintain low balances, you keep your credit utilization ratio low (below 30%), which can improve your credit score.
3. Make timely payments: It’s important always to pay your bills on time. Your payment history is the most important factor that makes up your credit score. Plus, some creditors and lenders may ding you with late payment fees or penalty high APRs.
4. Avoid multiple applications for revolving accounts: Be sure to check your personal credit score before you apply for a credit card, LOC, or HELOC to avoid a denial. Once approved, spread out future revolving account applications to avoid too many hard inquiries on your credit report. Hard inquiries can reduce your score by up to five points.
5. Plan for future expenses: If you have an expensive project, such as remodeling your home, consider using a revolving account. This will give you a credit line you can draw from throughout the project and save on interest. Conversely, an installment loan requires you to take out the full amount and pay back the loan with interest immediately.

Revolving accounts have their advantages and can be a beneficial financial tool. However, these accounts carry interest, various fees, and specific repayment schedules. This means it’s vital to use your credit wisely and responsibly.

Pros & Cons of the Revolving Credit

Revolving accounts are a solid way to pay the interest on the money you use and have funds readily available. You can use your credit to cover typical monthly expenses or unforeseen emergencies. However, you should also understand the disadvantages, such as potential high fees and the possible impact it can have on your credit score.

Pros of the Revolving Credit

The positives of revolving credit are:

• Pay interest only on the money you use: Compared to installment loans or nonrevolving credit, you’ll only have to pay interest on the money you draw. Installment loans require you to start repaying the loan amount plus interest and fees immediately.
• Funds are readily available: Revolving accounts give you access to funds you can draw from when and as you need. This creates a solution for when you need to cover monthly expenses before you have the cash in your bank account.
• Money is there in case of an emergency: Revolving accounts, such as credit cards and personal LOCs, can serve as a rainy day fund. When you run into emergencies or unexpected expenses, you’ll be able to draw against your credit line to temporarily cover those expenses.

Cons of the Revolving Credit

The drawbacks of revolving credit are:

• Can create a cash trap: Revolving accounts, especially credit cards and personal LOCs, often have high interest rates. If you don’t repay your balance in a timely manner, your creditor will charge you interest until the balances are fully repaid. This can create a cash trap that is difficult to overcome.
• Potential negative impact on your credit: If you use your revolving accounts irresponsibly, your personal credit score may be at risk. To avoid a negative impact on your credit score, be sure to maintain low balances, meet your repayment schedule, and control your spending.
• Misuse can lead to your account being closed: Frequent misuse of credit may indicate you’re a potentially risky borrower. Creditors and lenders may close your revolving accounts if you habitually misuse your credit.

Frequently Asked Questions (FAQs) About Revolving Credit

We covered a lot of information on revolving credit and the different types of accounts available. Some questions are asked more often than others, and we address those here. If you have any other unanswered questions, please feel free to share them on our Fit Small Business forum, and we’ll provide an answer.

What is a revolving line of credit?

A revolving line of credit is when a bank or lender offers an approved amount of money to a consumer or business for an indefinite amount of time. You can draw from them as needed, and you’ll only pay interest on the money you borrow. You can reuse the amount once the balance is repaid.

Does revolving credit hurt your credit score?

Revolving accounts can have a positive or negative impact on your credit score. The key factor that makes up your credit score is your payment history. Failing to make payments on revolving accounts can hurt your credit score. However, responsible credit use can also build a positive credit history.

What are examples of revolving credit?

The most common types of revolving credit accounts creditor and lenders offer are credit cards, personal lines of credit, and home equity lines of credit. Potential borrowers are only required to pay interest on the money they borrow, plus any other fees like annual fees or origination costs.

Bottom Line

Revolving credit is a handy way to have access to funds to use as you need, and you’ll only pay interest on the money you borrow. The most common revolving accounts are credit cards, personal LOCs, and HELOCs. Your spending goals, the amount of financing you need, and your qualification requirements likely determine which type of account is right for you.