How Revolving Credit Works
Revolving credit is a type of debt where there is no fixed installment each month. Instead, there is a credit line maximum, and any time you use the credit your purchase is deducted from that maximum. You can determine whether you want to repay the debt immediately or "revolve" it onto the next month. When you do not repay the debt in full, you are charged an interest rate. Revolving credit is not the same as installment credit. Installment credit refers to a loan paid back through monthly payments, or installments.
Examples of Revolving Credit
The most common example of revolving credit is the credit card. Each time you use your credit card, the purchase total is subtracted from your maximum allowable credit to give you a "remaining balance." You can continue to spend until you reach your maximum, commonly called "maxing-out." You are charged interest on each purchase. The longer you leave a balance on the credit card, the more that interest will compound, and the more you will owe. Other examples of revolving credit include home equity lines of credit and overdraft protection on checking accounts. A home equity line of credit is different than a home loan. It is credit extended to a home owner based on the equity he or she has in a home. A home equity line of credit usually comes with a credit card of its own.
Revolving credit is a very flexible option
that allows spenders to determine how much credit they need each month. A costly car repair can be placed on a revolving credit card and paid off over time. If you do not have large expenses the next month, you do not have to use your revolving line of credit at all. When you use revolving credit, you can also decide how much to pay each month based on your budget. If you need to carry a balance due to a vacation or the holidays, for example, you can choose to do so. With an installment loan, you would have to pay the same amount each month regardless of how much or how little you used the loan.
Disadvantages of Revolving Credit
Revolving credit can cause financial disasters if not used wisely. If you carry a balance each month and never pay down the debt, you will be charged very high interest rates that increase the cost of each purchase you make. Carrying a balance can also negatively effect your credit score. The healthiest credit scores show a mix of revolving credit and installment loans. Carrying less than 10% of your total allowable credit on a revolving line is the best way to boost your score. If your debt is out of hand due to credit card purchases, work to pay down the balance by making regular monthly payments and stopping your spending.
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