Revolving credit accounts let consumers repeatedly borrow capital up to a certain limit. Credit cards, personal lines of credit and home equity lines of credit are popular forms of revolving credit products, though each has different features and is used for different purposes. These are also structured differently from installment loans such as mortgages, student loans and auto financing.
- How Does a Revolving Credit Account Work?
- Revolving Credit vs. Installment Credit
- Types of Revolving Credit Accounts
- Important Things To Consider
A revolving credit account lets borrowers access capital up to a maximum limit. People can withdraw all or some of the available funds and choose to either repay the principal in its entirety or carry a balance to the next period. Minimum payments are usually due each month, but the amount depends on the terms of the loan agreement. Any principal that is repaid is eligible to be redrawn in subsequent periods, while any outstanding loan will usually incur interest charges.
An installment loan such as a personal or student loan lets you borrow a lump sum that is paid back in set monthly payments. Once you pay off an installment loan you’re finished with it, in which case you either take possession of the asset, such as with a car or house, or you simply walk away from the debt, like with a school loan. With a revolving line of credit, you can pay off the amount spent and then access the money again as long as the loan is still open.
Paying off debts in full and on time will improve your credit score. Credit agencies also compare the amount of revolving credit you have open at any one time with the amount owed. The lower this ratio, the better your credit score.
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The most common types of revolving credit accounts are credit cards, home equity lines of credit (HELOCs) and personal lines of credit. According to the American Bankers Association, there are 374 million open credit card accounts in the U.S., making it one of the most popular loan instruments. This form of revolving debt is intended to provide temporary spending flexibility and liquidity to make purchases that will be settled with a cash payment to the lending institution in a relatively short time span. The average annual percentage rate for credit cards is around 17.55%, although rates typically fall anywhere between 12.99% and 26.99%. These aren’t the highest rates consumers can incur, but they are among the most costly. As such, it’s usually wise to either keep credit card balances as low as possible or pay them in full every month, which lets you avoid finance charges.
A HELOC is a revolving credit account that lets consumers access the equity they’ve built up in their real estate properties. As the name suggests, these lines of credit are limited by the amount of home equity that can be collateralized. Many lenders also have uniform limits on the dollar amount available in a HELOC. These credit accounts are meant to finance large purchases such as home improvements, new property purchases and capital for businesses. Because HELOCs are secured by the value of real estate, they carry much lower interest rates than credit cards. Some people use HELOCs to consolidate other forms of debt such as credit cards, which have higher rates and shorter repayment periods. Before committing to a HELOC, homeowners should consider fees for application, origination, annual service and other items associated with these products.
A personal line of credit is a less common type of revolving credit account that works similar to a credit card. Borrowers are authorized to withdraw any amount up to a certain limit and they pay interest on the amount withdrawn. Unlike a HELOC, personal lines of credit are not secured by property, so they often carry comparatively high interest rates. The primary difference between personal lines of credit and credit card accounts is the physical card itself, which also functions as a payment solution at the point of sale.
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Revolving credit accounts can provide access to special benefits as well as liquidity for important purchases, investments or credit consolidation. Even with those advantages, it’s important to consider the financial impact of interest charges, monthly debt service payments and other costs before committing to opening a revolving credit account. Any loan will carry costs in the form of interest and fees, and the long-term benefits must outweigh that expense to justify the use of these products. Every dollar dedicated to repayment each month is unavailable for saving or consumption, which can have long-term ramifications.
You should also consider how revolving accounts affect your credit. Credit utilization is an important part of your credit score calculation, so carrying excess balances on credit cards might hurt your ability to access other loans in the future.
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This article has been updated with additional reporting since its original publication.