What is Revolving Credit? Understanding Credit Lines and How They Differ from Loans

Revolving doors are pretty clever if you ask me; they’re never quite open or closed. If a loan is similar to a door that you open once to purchase a big-ticket item like a car or house and close when you pay it off, credit cards and lines of credit are like revolving doors. In fact, these products are known as revolving credit.

Revolving credit allows you to borrow money up to a predefined credit limit and access funds repeatedly as you make payments on borrowed amounts. 

With revolving credit, you can keep borrowing money as long as you haven’t surpassed your credit limit. Revolving credit can be a powerful component in anyone’s financial arsenal, but borrowers who use it need to be mindful of how revolving credit works to maximize their use of it and minimize fees.

Misuse of revolving credit can damage your credit score, hindering your chances of securing credit products at favorable rates in the future. 

So step right up and enter the world of revolving credit. Don’t worry, you don’t need to check in with the doorman first. All you have to do is show up and read — we’re glad to have you with us.

With so many types of loans available in the lending space, you might wonder why revolving credit products are necessary. For starters, they offer borrowers the flexibility to manage their credit how they best see fit. And when it comes to managing your money, it’s nice to have options.

Credit Limits

When mortgage applicants are approved for a loan, they use the money their creditor has loaned them to buy a house. They’re then responsible for making payments on the loan until they’ve paid the lender back for the amount of the loan and any interest it has accrued. The loan’s funds aren’t automatically replenished for continued use by the borrower as they make payments on their loan. Revolving credit is different.

Though credit limits restrict the use of revolving credit to an extent, the credit limit can reset repeatedly as a borrower pays off the balance. Lenders may raise a borrower’s credit limit over time to entice them to spend more with a revolving credit product.

Consider the example of borrowers Eleanor and Robert:

• Eleanor secures a personal loan in the amount of $10,000 to fund a home improvement project. She uses the loan to pay a contractor and buy supplies. When she spends the full $10,000, the loan is depleted.
• Robert secures a line of credit in the amount of $10,000 to fund a home improvement project. He spends up to his product’s $10,000 credit limit during the first month after he opened the line. 

After Robert pays his lender back the money he borrowed plus the interest charges he accrued, he may decide that he liked his home better before the project, so he wants to undo it. He again accesses his $10,000 line to fund the renovation.

Robert’s line of credit remains available to him in full because he paid off the balance in full. If Eleanor decided she wanted to use her loan again to reverse her home improvement project, she wouldn’t be able to. She’d have to apply for another loan or a revolving credit product.

Flexible Repayment Options

A borrower who takes out a loan is responsible for repaying the loan with interest over an established time period. An amortization schedule details the future payments for a loan. 

Borrowers using a revolving credit product don’t need an amortization schedule because they don’t have to make regular, predetermined payments. They can pay back as much as they want to, or can afford to, in a given period.

Payment flexibility is one reason revolving credit is a popular option for those who want a little wiggle room.

But borrowers need to understand that unpaid amounts on revolving credit products will generate interest, so it’s not a wise move to ignore revolving credit balances.

Even if you can’t repay the full amount you owe on a revolving credit product in a given month, you can submit partial payments. Partial payments allow borrowers to make a dent in their outstanding balance and reduce interest charges.

Continuous Access

Some people like black licorice. Some people like waking up at 4:00 AM to go to the gym. The world is full of all sorts of people, but I’ve never met someone who enjoys filling out loan applications and waiting to hear whether they were approved.

A benefit of revolving credit is that it allows borrowers to save time by using credit time and again without reapplying for it. 

Poor Eleanor has to sharpen her pencil, fill out her application, and hope her creditor approves it before beginning her next home project.

Not Robert, though — his revolving credit is ready and waiting for him, provided his use of the product hasn’t temporarily exceeded its credit limit.

If you’re in need of financing to help you reach your goals, revolving credit may be the bridge that takes you where you want to go. Revolving credit comes in many forms. 

Though similar in structure, a closer look reveals nuances among products in the revolving credit marketplace. 

Credit Cards

Credit cards are the most common type of revolving credit. Almost everyone is familiar with credit cards, even if they don’t own one themselves. Credit card issuers frequently run advertisements online or during popular television programming to ensure their card is top of mind for consumers in the hunt to expand their purchasing power.

When you make a purchase using your credit card, card issuers track the transaction. They’ll send you a billing statement each month with a record of all your transactions made during the period.

If borrowers pay their balances in full each month, they may be able to avoid interest charges if their card has a grace period.

Interest rates vary by card issuer but are usually higher than the rates offered on traditional loans. Cardholders can make purchases up to their card’s credit limit, which is replenished as borrowers make payments to their issuer.

Credit cards are also practical financial tools. You can carry your card in your wallet wherever you go, so you’re always prepared for unexpected expenses. 

Home Equity Lines of Credit (HELOCs)

Many people aspire to own a home of their own one day — it’s part of the American dream. When you own your home, you can decorate it without having to worry whether your landlord approves of your plans for the space. Homeownership also allows you to access a unique financial tool — a home equity line of credit (HELOC).

A HELOC allows you to use the equity in your home, which is the value of your house minus the remaining balance of your mortgage, to make purchases. 

With a HELOC, a borrower can spend up to the product’s limit and borrow again as they pay off their balances. You can use your HELOC to pay for big purchases, like a home renovation, or help with unexpected expenses. A HELOC operates similarly to other revolving credit products, with a few key differences.

A standard HELOC offers borrowers a draw period, which is the time when they can borrow funds through the product. Draw periods typically last at least 5 years, with many extending up to 10 years or more. Consumers typically use special checks issued by their lenders to make purchases through their HELOC.

After the draw period concludes, the repayment period begins. Though borrowers were likely required to make payments during the draw period, that process intensifies in the repayment period. Your HELOC provider will require you to pay off the total amount of money you borrowed, plus interest, during the repayment period, which usually lasts for 10 years or more.

Your HELOC is secured by your home, so borrowers who aren’t diligent in keeping up with payments run the risk of losing their homes.

Personal Lines of Credit

Last and also least, in terms of popularity among revolving credit products, are personal lines of credit. Personal lines of credit give you access to money up to a credit limit, and you’ll be required to repay amounts borrowed and interest to your creditor.

 As with other types of revolving credit, personal lines of credit can be used to pay for whatever you wish.

A personal line of credit can be useful to consumers who lack an emergency fund to pay for unexpected expenses.

Those who need ongoing access to cash to finance a project but aren’t sure exactly how much they’ll need over time can also benefit from a personal line of credit.

Your lender may charge you higher interest fees for a personal line of credit than a HELOC because the HELOC is secured by the equity in your home. 

The time value of money tells us that $100 today is more valuable than $100 a year from now. That’s one of the reasons that creditors charge borrowers interest when they issue credit. 

Lenders seek to be compensated for the money they loaned to you, and they earn revenue through fees and interest expenses. 

Interest on Unpaid Balances

Your credit card issuer will bill you each month for purchases you make with your card. If you pay the balance in full before its due date (if your card has a grace period), then you won’t be charged any interest fees for that month. But if you make only the minimum payment instead, you’ll lose it.

But cardholders who don’t pay their balance in full will be charged interest on any unpaid portions of their balance. 

Lines of credit work differently than credit cards when it comes to interest. Your lender will most likely charge interest on any portion you borrow against your line as soon as you borrow it. 

Fixed interest rates often accompany traditional lending products such as mortgages and auto loans. Variable interest rates are more commonly charged to revolving credit products — or adjustable-rate mortgages. 

You should read your revolving credit product’s terms carefully to understand how your lender calculates interest charges and when interest begins to accumulate. 

Minimum Payment Requirements

Amusement parks offer all sorts of tantalizing foods that sometimes look better than they taste. It wasn’t uncommon for my eyes to be bigger than my stomach when selecting a snack while I was visiting one. That led to either wasted food or an upset stomach, which isn’t ideal when you’re subjecting yourself to nausea-inducing rides ad nauseam.

When you bite off more than you can chew with a revolving credit product, your finances can take a hit. Your lender will require you to make a minimum payment each month on the amount you borrowed.

If you’re not able to pay a minimum payment for a particular period, you may be charged a late fee.

But that’s not all; failure to make a minimum payment can damage your credit score. You may also incur penalty interest rates when you miss minimum payments.

Paying your balance in full can help you steer clear of fees, but at least strive to make the minimum payment to avoid further costs.

Fees Associated with Revolving Credit

In addition to late fees, lenders who issue revolving credit may also charge other fees. Annual fees are charges imposed on borrowers just for owning a product.

That means that even those who are responsible for paying their balance in full and on time each month will incur the fee.

Borrowers who access funds beyond their credit limit may be charged over-limit fees. Monitoring your balance and careful planning can help you avoid this fee.

Other fees, such as cash advance fees and foreign transaction charges, are also common with credit cards.

When you arrive at one of life’s crossroads and don’t know which way to go, it can help to make a list of the pros and cons of choosing either path. Revolving credit can amplify your purchasing power, but those who understand the ins and outs of using it can better manage their finances.

Benefits

• Financial Flexibility: It’s always good to have options in life, especially when it comes to your finances. Revolving credit lets you decide how much of your credit you want to use, so you’re not on the hook for borrowing more than you need. You also have payment flexibility with revolving credit. You can pay it all back or make the minimum payment if your budget is tight — but I don’t recommend that.
• Building Credit History: Lenders can be eager to provide financing to borrowers with strong credit profiles. You can improve your credit score by regularly using revolving credit and submitting on-time payments to your lender. 
• Rewards Programs: Rewards are one of the best features of credit cards. Card issuers offer all sorts of rewards programs, including those with airline miles, points for merchandise, or cash back on each purchase made. By managing your card spending to earn rewards, you’re essentially saving money on each purchase you make with your credit card. Don’t discount the significance of rewards programs. I’ve heard stories of people paying for most of their vacations with their credit card rewards, so learn how to maximize your card’s rewards if a free vacation sounds good to you.

Potential Drawbacks

• Risk of Overspending: Using revolving credit may feel like having access to free money, but you will need to repay the amount you borrow. Be careful not to spend more than you can afford to pay back. Your long-term finances will thank you for it.
• Possible High Interest Rates: Interest rates can be higher on revolving credit products than on other loan types. And variable interest rates make it difficult to estimate just how much interest you can accrue on future balances. Pay your balances off on time to avoid interest fees that can add up quickly.
• Impact on Credit Score: Missed payments on revolving credit can really hurt your credit score. Carrying high balances can cause your credit utilization ratio to skyrocket, which also harms your score. If you want to maintain or improve your score, don’t be lax in paying off revolving credit.

Are you in the market for a credit product that grants you flexibility to manage your borrowing in a way that suits your financial lifestyle? If so, revolving credit may be the product you’ve been seeking. 

Life is always changing. Concerns about which snacks you’ll get at the amusement park are soon replaced by worries about paying for college and funding retirement plans. As your financial needs are evolving, consider credit that’s revolving.