Definition
Revolving credit is a type of credit arrangement that allows a borrower to repeatedly access funds up to a predetermined limit, repay all or part of the borrowed amount, and then borrow again without having to reapply. The most common examples are credit cards and lines of credit. With revolving credit, your available credit decreases as you borrow and increases as you make payments. You're typically required to make at least minimum monthly payments, but you can choose to pay any amount between the minimum and the full balance. Interest is charged on the unpaid balance, which can vary from month to month. Revolving credit offers flexibility in borrowing and repayment, but often comes with higher interest rates than installment loans. How you manage revolving credit accounts, especially your credit utilization ratio, can significantly impact your credit score.
Frequently Asked Questions
What's the difference between revolving credit and installment credit?
Revolving credit allows you to repeatedly borrow up to a specific limit, make variable payments, and reborrow without reapplying. There's no fixed repayment timeline, and interest is charged only on the outstanding balance. Examples include credit cards and lines of credit. Installment credit provides a one-time loan of a specific amount that you repay through fixed regular payments over a set period. Once repaid, the account closes, and you must apply for a new loan to borrow again. Examples include mortgages, auto loans, and personal loans. Both types affect your credit score, but revolving credit utilization has a more significant impact.
How does revolving credit affect my credit score?
Revolving credit affects your credit score in several ways: (1) Credit utilization ratio (the percentage of available credit you're using) significantly impacts your score—keeping it below 30% (ideally below 10%) is best; (2) Payment history on revolving accounts is crucial—late payments seriously damage your score; (3) The number of revolving accounts contributes to your credit mix; (4) Revolving account age helps establish length of credit history; and (5) Applications for new revolving credit generate hard inquiries. Generally, revolving credit has a more substantial impact on your credit score than installment credit, particularly regarding utilization.
What are the advantages and disadvantages of revolving credit?
Advantages of revolving credit include flexibility (borrow only what you need when you need it), convenience (no need to reapply after repayment), potential rewards (many credit cards offer cash back or points), and credit building potential when used responsibly. Disadvantages include higher interest rates compared to installment loans, the potential for accumulating debt due to low minimum payments, variable payments that can complicate budgeting, potential for high fees (annual fees, late fees, over-limit fees), and the risk of damaging your credit score if you maintain high balances relative to your credit limits.
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