Revolving credit is a type of debt generally associated with credit cards because as consumers pay down their balance each month, they are able to incur more charges. Other types of revolving credit include lines of credit, such as a home equity line of credit commonly known as a HELOC.
The credit limit is established by the lender and can increase or decrease depending on certain factors such as the payment history of the consumer.
Installment credit is the other type of credit consumers often use and are familiar with. These include student loans, mortgages and auto loans. Lenders will give consumers a loan for a set amount that you will pay back monthly during a fixed period of time, such as a $20,000 car loan for six years.
Unlike installment credit, the interest rate on revolving credits can fluctuate, which means the monthly payments could also rise.
When to Use Revolving Credit
Consumers often use revolving credit to finance purchases and to establish a credit history. Lenders want to see a history of consumers paying their bills on time; the best way to do this is by using a credit card for purchases that can be paid off, on time, in its entirety.
Credit cards are often convenient to use at gas stations, shopping online or with retailers because they offer more fraud protection.
How It Works
Revolving credit is more flexible because consumers can choose to use it occasionally or every week. The best strategy is to pay off the revolving debt in full each month. Credit cards give consumers the option to carry their balance over each month which is otherwise known as “revolving” the balance.
Any balances which are carried over to the next month will be charged with interest, which adds to the initial principal amount. Annual fees and late payment fees are also charged by many credit card issuers.
How Revolving Credit Affects Your Credit
Consumers, who primarily use their debit cards or haven’t had a credit card before, need to establish or build their credit history, especially if they do not have any other debt such as student or auto loans. Charges made on a debit card are not counted towards a person’s credit history, so don’t help your credit scores.
Lenders want to see a history of how much is paid off each month, if you are paying the bills on time, and how close you are to your credit limit, which is called the credit utilization ratio. A lower credit utilization ratio is what lenders are looking for, so maintaining a lower balance and paying off the entire amount each month is a good strategy.
When consumers are seeking a large type of loan such as a mortgage to purchase a home, lenders usually want to see both revolving and installment credit. This demonstrates to lenders that you can balance all of your financial responsibilities.
A longer credit history and higher credit scores usually mean consumers will receive a lower interest rate for their loans. A lower interest rate results in individuals being able to pay down the principal faster and be debt-free sooner.
Advantages of Revolving Credit
One benefit of using revolving credit such as a credit card is there is more protection for the consumer in case of theft or fraud. Consumers are generally not responsible for identity theft, fraudulent charges or a lost or stolen card. Even if a cybercriminal runs up the balance, the lender will not hold the consumer responsible while the incident is under investigation.
On the other hand, if a thief uses a consumer’s debit card, a depleted balance might impact any bills that are automatically paid or result in the payment not going through. There is greater risk involved using a debit card because the balance is linked to a checking account.