Understand How Revolving Credit Works and How to Use It

Revolving credit is a flexible loan method that allows consumers to access a line of credit without a fixed repayment term.  

In the United States, it is widely used in credit cards and other types of loans, such as personal lines of credit or home equity lines.  

While it offers a practical way to manage cash flow, revolving credit can become a financial burden when mismanaged due to the high interest rates associated with it.  

In this post, discover all the details about what revolving credit is, how it works, its advantages and disadvantages, and how it can impact your credit score.  

How does revolving credit work?  

Revolving credit functions as an open loan, where the lender sets a maximum limit that the consumer can use.  

The main characteristic of this type of credit is flexibility: there is no fixed due date for the total balance. And the consumer can pay the minimum amount required by the financial institution, leaving the remaining balance for the next month.  

If you have a credit card with a $5,000 limit and spend $1,000 in one month, you can choose to pay only part of that amount, such as $200.  

The remaining balance of $800 will be carried over to the following month, with added interest on the unpaid amount. This cycle repeats, allowing the consumer to continue using the credit as long as they don’t exceed the available limit.  

Therefore, this flexibility is the great advantage of revolving credit but also its greatest risk. Interest rates for revolving credit are quite high, which can quickly increase the amount of your debt.  

What are the main types of revolving credit?

There are several examples of revolving credit, with credit cards being the most common. However, other forms of credit work similarly.  

Here are some of the main types and learn more about each of them.  

1. Credit Card

The credit card is by far the most common example of revolving credit. When you make purchases with the card, the financial institution offers you the option to pay the total balance by the due date or just the minimum amount required.  

Any unpaid balance will be carried over to the next month with added interest. 

In the United States, credit card interest rates can vary greatly, but it is common for them to exceed 20% per year. If you fail to pay the full balance, the debt can grow quickly.  

2. Personal Line of Credit

A personal line of credit is a loan that works similarly to a credit card.  

The consumer is given a credit limit that can be used as needed, and they have the flexibility to pay off the total amount or just part of the debt each month.  

As with a credit card, a personal line of credit offers the advantage of flexibility, but the interest rates are also high, especially for consumers with poor credit history or a low credit score.  

3. Home Equity Line of Credit (HELOC)

In this type of revolving credit, the consumer uses their own home as collateral to obtain a credit limit. This form of credit is known as a Home Equity Line of Credit (HELOC) in the United States.  

The advantage is that the interest rates are usually lower than others since the risk to the lender is reduced by the collateral offered with the property. However, the risk to the consumer is greater because the property can be seized in case of default.  

The HELOC offers flexibility and is often used for large expenses, such as home renovations or paying off larger debts.  

What is the difference between revolving credit and installment credit?  

It’s important to understand the difference between revolving credit and installment credit.  

In installment credit, the consumer takes out a loan with a fixed amount and repays it in regular installments until the contract ends. A common example of installment credit is auto financing or a traditional personal loan.  

In revolving credit, there is no fixed monthly payment amount, and the consumer can choose to pay the minimum required or more, depending on their financial capacity.  

This offers greater flexibility, but at the same time, it can result in higher costs with interest if the balance is not paid in full by the agreed deadline.  

How revolving credit can affect your credit score 

The use of revolving credit in the United States can seriously impact your credit score, especially if you maintain a high balance or only make minimum payments.  

Several factors affect your credit score, but here are the main ones related to revolving credit. Check it out:  

• Credit utilization ratio: This is the percentage of your credit limit that is being used compared to the total available. Ideally, you should keep this ratio below 30%. If you use a large portion of your credit limit, it can signal to lenders that you are financially overburdened.  
• Payment history: Paying only the minimum affects your credit score, but paying late or missing payments is even more detrimental. Payment history is the most important factor in determining your credit score.  
• Length of credit history: The time you maintain an open line of credit also affects your score. Keeping a credit card account open for a long period, even if it’s revolving credit, can be beneficial as long as you use it responsibly.  

Is revolving credit good? Know the pros and cons 

Now that we understand how revolving credit works, it’s important to analyze the pros and cons to decide if it’s right for your financial situation at the moment. Let’s take a look!  

Advantages

• Flexibility: Revolving credit offers great payment flexibility, allowing the consumer to choose how much to pay each month. This is useful in emergencies or when your cash flow is tight.  
• Continuous access to credit: As long as you pay the minimum amount, you can continue using the credit, which is an advantage over installment credit, which has a fixed payment limit.  
• Ease of approval: It is often easier to get a credit card or a personal line of credit than an installment loan, especially for consumers with a good credit history.  

Disadvantages 

• High interest rates: The main disadvantage of revolving credit is the cost. Interest rates can be extremely high, especially on credit cards, making debts difficult to manage in the long term.  
• Impact on credit score: Using a large portion of your credit limit lowers your credit score, and minimum payments extend the debt for a long time, increasing the total cost.  
• Possible financial trap: Due to the payment flexibility, many consumers end up paying the minimum and allowing the balance to grow, which can lead to unsustainable debt and various complications.  

Revolving credit is a powerful financial tool when used responsibly and with proper planning, offering flexibility to manage expenses and emergencies.  

Remember that it’s essential to be aware of the high interest rates and the potential impact on your credit score.  

If you choose to use this type of credit, keep a low utilization rate and pay off the total balance whenever possible to avoid long-term financial issues.  

If you’re looking for financial flexibility, revolving credit can be a useful solution, but it can also become a trap if not used with great caution.  

Are you now more aware of how revolving credit can fit into your daily life and significantly help your financial needs? Use our tips to use it smartly and strategically.  

Also, read our post about the types of rewards offered by credit cards!