Are you thinking of opening a revolving credit account, but you're worried about how it might affect your credit score?
While having a variety of credit types can help you build up credit, it's essential to use your credit responsibly to achieve the most positive effect.
Keep reading to learn all about revolving credit, how it affects your credit score, and what to do to avoid bad credit.
What is revolving credit?
Revolving credit — also known as rolling credit — lets you borrow funds, repay them, and then borrow them again on a revolving basis.
You're free to use as much (or as little) of the available funds as you'd like during your billing cycle, and your minimum required payments and applicable interest depend on your total borrowed amount.
Revolving credit accounts are open-ended, meaning you can continue to use your account as long as it's open and in good standing.
How it works
When you open a revolving line of credit, the lender sets a credit limit that determines the maximum amount you can borrow from that account. Every time you spend money from the account, it reduces your available credit. When you make a payment, your available credit goes back up.
If you pay your full balance on time at the end of the billing cycle, you won't have to pay any interest, and your credit limit returns to its original amount.
But if you only make the minimum payment (or any amount less than the full balance), you'll be charged interest on the balance that "revolves" into the next billing cycle. Also, your available credit limit will decrease by the amount you owe, including interest.
Revolving credit vs. installment credit
Unlike installment credit, revolving credit only charges you for the amount you use. When your billing cycle ends, you can pay back either the full amount you spent or a minimum payment plus interest on the remaining balance. Revolving credit also lets you borrow more funds in the next cycle, so long as you still have available credit in your account.
An installment loan, on the other hand, is a type of non-revolving credit. That means you get a fixed amount of funds upfront and pay them back in regular installments over a set period. You can't access more funds over the life of the loan, and your account closes when you complete your repayment schedule.
Examples of revolving credit accounts
Credit cards are one of the most common types of revolving credit.
Personal lines of credit
Similar to credit cards, personal lines of credit let you borrow only the amount you need and pay it back in full or in installments.
Home equity lines of credit (HELOC)
A home equity line of credit is an open-ended credit account that lets you borrow money against the value of your home.
Business lines of credit
A business line of credit is a revolving loan used to meet short-term business needs.
Margin investment accounts
A margin investment account is a brokerage account that allows you to borrow money for specific types of investments.
Pros and cons
- Flexibility: Revolving credit allows you to borrow only what you need and pay it back either in full or in installments over time.
- Limited interest: Interest on revolving credit is calculated only on what you borrow. If you pay your full balance by the due date every month, you can avoid interest altogether.
- No collateral: Most revolving lines of credit are unsecured, meaning you don't need collateral to gain access to them.
- Continuous access: You can borrow and repay funds as often as you need.
- Perks: Many credit cards offer rewards and cash-back on the amount you spend.
- Credit score requirements: Revolving credit is generally unavailable to those with a bad credit score.
- Annual fees: Depending on the lender, they may charge you maintenance or late payment fees.
- Higher interest rates: Although the amount of interest is limited to what you borrow, the interest rates on revolving credit may be higher than non-revolving credit products.
- Interest isn’t tax-deductible: Unlike with mortgages, student loans, and business loans, the interest you pay on revolving credit isn’t tax-deductible.
- Can hurt your credit score: As with any type of credit, your credit score can take a hit if you keep a high balance or fail to make timely payments.
How to get revolving credit
Applying for revolving credit is the same as applying for any other type of loan.
Start by shopping around to see what offers are available from different banks, credit unions, and credit card issuers. Pay special attention to credit limits, interest rates, fees, credit requirements, and rewards. Once you've found the best deal you're eligible for, gather all the necessary documents and complete an application.
Approval time can vary from the same day to several weeks, depending on the lender and the type of credit. Once you receive confirmation of your approval, you're ready to start spending from your available credit.
Ways to avoid revolving credit affecting you negatively
Like all types of credit, revolving credit has the potential to affect your credit score. The impact can be positive or negative, depending on how you make use of your credit.
How to keep a good credit score
If you already have a good credit score, there are a few things you can do to make sure it stays that way.
Keep a low balance
Avoid spending too much on your revolving credit account. By doing so, you’ll help keep your credit utilization ratio low, which in turn helps boost your credit score.
Pay your bill on time
Payment history is the most important factor in determining your credit score, so don't forget to make timely monthly payments.
Get a higher limit
If your lender offers you a higher credit limit, it's often a good idea to accept the offer. That's because a higher limit means a lower utilization ratio. You can also request a higher limit, but your credit score will take a temporary hit if you do.
Don't close your account
Even if you don't use it very much, keeping your revolving account open contributes to the length of your credit history and your credit mix, both of which positively impact your credit score.
What is revolving usage percentage?
Your revolving usage percentage (also known as your credit utilization ratio) is the amount of available revolving credit that you're using at a given time.
For example, if you spend $500 on a credit card with a limit of $5,000, your usage is 10%.
What is a good percentage target?
The lower your credit utilization rate is, the better it will impact your score.
Using more than 50% of your available credit suggests that you're a risky borrower. Most experts recommend keeping your total utilization ratio across all credit accounts at 30% or lower.
To improve your credit score, you should aim to keep your revolving credit utilization below 10%.
The bottom line
Revolving credit can positively or negatively affect your credit score, depending on how you use it. If you get a revolving line of credit or credit card, remember to keep your balance low and make your payments on time.
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