Takeaways
- Revolving credit accounts are popular for funding daily expenses.
- Revolving credit lets you borrow repeatedly without frequent credit checks.
- Revolving credit includes credit cards, home equity, and personal lines of credit.
- Revolving credit accounts only charge interest on interest on borrowed funds.
- Account holders can “revolve” unpaid balances from one month to the next if they make minimum monthly payments.
What Is Revolving Credit?
Revolving credit is one of the most flexible financing products available to those needing consistent credit access. It is a product offered by banks, credit unions, and other lenders that allows you to borrow funds, pay for those funds, and draw down on the credit line again. A revolving credit account comes with a pre-established credit limit.
Revolving credit works differently from traditional loans. Instead of getting a lump sum principal deposit that immediately begins to accrue interest, you have continuous access to a credit account that only starts accruing interest on funds you utilize.
With a revolving credit account, you can use funds at your discretion. At the end of the month, you will receive an account balance. Once you have your statement balance, you have two options:
- Pay back the borrowed funds by the statement due date. If you pay off your monthly account balance, no interest is charged, and your available credit will increase back to your credit limit (assuming you pay the account balance in total).
- If you don’t pay back your monthly balance, it “revolves” to the next month. At this point, you must make a minimum payment of either a percent of the balance or a nominal fee. You can continue spending from your credit account until you reach your limit.
Revolving credit is incredibly popular for managing personal finances and business operations, particularly for those who need help managing cash flow, covering unexpected expenses, or financing ongoing projects.
The most well-known types of revolving credit are credit cards, personal lines of credit (PLOC), and home equity lines of credit (HELOC). Each credit product offers an avenue for accessing the funds you need.
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Advantages of Revolving Credit
A revolving credit account can be beneficial for making everyday purchases, financing large items, or taking advantage of rewards programs. Here are several pros to consider:
- Interest: With a revolving credit account, interest is charged on the amount you borrow, not your credit limit. This makes revolving credit an extremely cost-effective option for managing short-term financial emergencies, cash gaps, or periods of irregular cash flow.
Additionally, your monthly payments vary based on the amount you borrowed and your credit agreement's specific terms and interest rate. There is no fee if you don’t borrow funds.
- Access to Funds: Another significant pro of a revolving credit account is the ability to quickly access funds without having to reapply for a new loan each time.
This convenience is an important selling point for those considering using their revolving credit line frequently to manage day-to-day expenses (either personal or business).
- Cash Management: A credit line helps manage the periodic cash shortfalls and allows you to pay for items or services you need when you don’t have cash.
This can be super beneficial if you are a freelancer, have an irregular income, or own a cyclical business. However, you need to manage this access to credit effectively to ensure you don’t get into debt.
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3 Types of Revolving Credit Accounts
Revolving credit facilities come in various options; each credit product suits different financial needs. Below are three common examples of a revolving credit facility: credit cards, PLOCs, and HELOCs.
1. Credit Cards
Credit cards are one of the most widely used types of revolving credit, and here is how credit cards work. Cardholders are provided with a line of credit that they can use to make regular purchases. This buy now and pay later approach allows you to make purchases when necessary without considering how much cash you have.
Credit cards come with a credit limit, and you are capped on how much you can use your credit card. You can begin spending again once you pay your credit card bill because you have restored your available credit. (Read about how to increase your credit limit.)
Pros: Credit cards are incredibly convenient, flexible, and secure payment cards. They also help build credit history, which is reported on your credit report. They are accepted almost universally and can offer rewards, points, and cash-back programs.
Cons: Credit cards tend to have much higher interest rates than other forms of borrowing, and they are also notorious for applying fees. [1] With such easy access to credit, it can be tempting to spend frivolously.
2. Personal Lines of Credit
Another revolving line of credit is the personal line of credit (PLOC). A PLOC can create a source for flexible and fast funding up to an established limit. They are generally only offered by banks and credit unions and have lower interest rates than credit cards.
Pros: Personal lines of credit have repayment flexibility. With a PLOC, you can pay a minimum or a larger payment to reduce your principal balance more quickly.
Cons: To secure a personal line of credit, you often need a relatively good FICO score. This can be challenging if you have a low credit score and need time to improve your credit score. PLOCs have variable interest rates, making the predictability of interest payments difficult.
3. Home Equity Lines of Credit
A home equity line of credit (HELOC) is a form of secured revolving credit that holds the equity in a borrower’s home as collateral. HELOCs give borrowers access to a line of credit based on the value of their home, less any mortgage balance. This can be an excellent financing option for first time homeowners who want to tap into the value of their home.
Pros: One of the most significant advantages of a HELOC is the lower interest rates compared to other unsecured options. Also, the interest you pay on a HELOC may be eligible for tax deduction, which can create an additional tax benefit to use as a funding source.
Cons: As a collateralized loan, HELOCs put your home at risk. If you fail to make payments, banks, credit unions, or financial institutions can use your collateral to pay down your debt.
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Revolving Line of Credit vs. Installment Loan
Revolving lines of credit and installment loans are two very different financing tools, each with unique pros and cons. Understanding the differences between your options can help you select the smart choice for your specific needs. Here are the main differences between the two options:
- Revolving Line of Credit: A revolving line of credit will provide flexible, easy access to funds up to a predetermined credit limit. You can borrow, repay, and reborrow as needed if you adhere to the terms of the credit line.
Instant access to a revolving line of credit is an excellent choice for managing a sporadic or irregular cash flow or covering unexpected and substantial expenses. Interest expense is applied to borrowed funds, and interest payments scale in proportion to the amount of credit used.
Examples of revolving lines of credit include credit cards, personal lines of credit, and home equity lines of credit. The primary advantage to each is the ongoing or “revolving” access to funds after repayment, eliminating the need to apply for a new loan each time.
- Installment Loans: An installment loan provides a lump sum payment to the borrower, which immediately begins accruing interest at a fixed rate. They are dubbed installment loans because you pay them back with installment payments, usually monthly payments.
The most common types of installment loans are auto loans, mortgages, and personal loans. The most significant benefit of an installment loan is the predictability of principal and interest payments.
When debating whether you need a revolving line of credit or an installment loan, the decision will come down to the specifics of your financial situation and immediate financial needs.
If you need ongoing access to funds and more repayment flexibility, a revolving line of credit could be exactly what you need. Alternatively, if predictability and a clear payment schedule are better for your personal finances, an installment loan might be the better option.
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Smart Summary
Many personal finance experts advocate managing your expenses with a monthly budget. How you manage the payment for these expenses is a matter of personal preference for large and small purchases. Millions of households use revolving credit accounts to fund daily purchases, finance large-ticket items, and get the cash they need to make unexpected purchases. Managed carefully, revolving credit accounts can increase your credit score and lower the cost of borrowing funds in the future.
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(1) Consumer Financial Protection Bureau. CFPB Bans Excessive Credit Card Late Fees, Lowers Typical Fee from $32 to $8. Last Accessed January 14, 2025.
