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What is a revolving credit account?
A revolving credit account is a type of credit account that allows you to repeatedly borrow money (up to a set limit) and pay it back over time.
Credit cards are the most common type of revolving credit account, and they’re the kind that most people are familiar with. When you use a credit card, you can borrow as much money as you’d like, up to a maximum called your credit limit. Any money that you don’t pay back that month gets “revolved” (rolled over) into the next month, which is where the name “revolving credit” comes from.
Many revolving credit accounts have no expiration date, which means that they can stay open indefinitely as long as you make your payments on time and the account remains in good standing.
The open-ended approach of revolving credit can be contrasted with installment credit, in which you receive a single loan which you pay off (usually according to a predetermined schedule) until your debt is cleared. Mortgages and auto loans are some of the most common types of installment credit.
Types of revolving credit
The three most common types of revolving credit accounts are credit cards, personal lines of credit, and home equity lines of credit (HELOCs).
Credit cards
Credit cards are the most popular type of revolving credit. They can be used for expenses of all sizes and have flexible credit limits.
Your initial limit is set when you’re approved for a card and determines how much money you can spend. You can increase your credit card limit if you prove yourself to be a reliable borrower.
Credit card terms vary by card and company, but you usually need to pay off the balance on your card every month or pay interest on the amount remaining.
Your interest rate depends on the card and your credit score. The Federal Reserve reported that in May 2021, the average (annual) interest rate for credit cards was 16.3%.1
Personal line of credit
A personal line of credit is similar to a credit card—it’s a credit account that you can withdraw money from periodically, which you then pay interest on until it’s all paid back. The main difference is that personal lines of credit are generally used for larger expenses, like medical bills or renovations, whereas credit cards are usually used for smaller purchases.
It’s common for creditors to deposit funds from a personal line of credit directly into your bank account via a check or wire transfer, although some lenders also issue cards that you can use to access your personal line of credit.
Home equity line of credit
A home equity line of credit (HELOC) is a type of secured credit where the borrower’s home serves as collateral, similar to a mortgage. Instead of providing the full loan amount at once, your lender extends a revolving credit line equal to up to 85% of the equity you have in your home (i.e. how much of your mortgage you’ve paid off).2
HELOCs feature a defined draw period and repayment period. As the name suggests, you can withdraw funds during the draw period. You can also pay as much back as you like during this period, but you’re only required to pay the interest.
During the repayment period, you can’t withdraw any more money, and you have to pay your remaining debts back according to a set payment schedule, much like you would for an installment loan.
Secured vs. unsecured credit
There are two types of revolving credit: secured and unsecured.
Secured revolving credit
Secured credit is backed by collateral, usually in the form of an asset, like real estate, a vehicle (e.g. a car), or some other valuable piece of property. For example, a home equity line of credit uses your home as collateral, and a business line of credit often uses business property or equipment.
Examples of secured credit cards:
Unsecured revolving credit
Unsecured revolving credit isn’t guaranteed by collateral. Most credit cards are unsecured revolving credit, with the exception of secured credit cards, which require a cash deposit that serves as collateral.
Unsecured credit tends to be harder to get (meaning you have to have a higher credit score to qualify) and comes with a higher interest rate because the lack of collateral means higher risk for the lender.
Examples of unsecured credit cards:
How does revolving credit work?
Revolving credit works the same way that other types of credit do. To get a revolving credit account, you need to contact a creditor, such as a bank, and submit an application. (Note that they may deny your application if you have a bad credit score, or if you have an insufficient credit history.)
If they do approve your application, your creditor will set your credit limit, which is the maximum amount of money you can withdraw from your credit account at any given time.
When determining your credit limit, your creditor will consider your credit score and payment history, your income, and your employment stability. Credit limits aren’t always fixed; if you consistently pay your bills on time, your lender may conclude you’re a dependable borrower and be willing to raise your limit. In many cases, raising your credit limit will increase your credit score.
How paying for revolving credit works
If you can’t pay your debt in full by the end of a given billing period, you can make the minimum monthly payment required for your account, and your remaining balance will carry over (“revolve”) into the next billing period. Depending on your lender, your minimum payment might be a fixed amount or a percentage of your credit balance.
The unpaid balance that you carry over into the next billing period will accrue interest, although some lenders will offer a 0% interest introductory period when you open an account. Generally speaking, once this period has passed, revolving credit accounts have higher interest rates than installment loans.
Advantages of revolving credit
Revolving credit has several major advantages:
- It’s flexible: Revolving credit accounts extend the amount of money you have access to and give you the freedom to choose when to access those funds. The most common revolving credit accounts, credit cards, also save you from having to carry cash everywhere you go.
- Many lenders offer rewards: One of the main benefits of having good credit is that many lenders will offer you incentives (such as cash-back rewards) for using their accounts.
- It builds your credit: Opening a revolving credit account and using it responsibly is one of the best ways of building your credit, which will increase your credit score.
Disadvantages of revolving credit
Revolving credit also has certain disadvantages:
- High interest rates: Revolving credit tends to have higher interest rates than installment credit.1 Card issuers can also sometimes increase your interest rates, though they’ll usually need to notify you 45 days in advance.3
- Extra fees: Revolving credit also frequently comes with annual fees, origination fees, commitment fees, and missed or late payment fees.
- Risk of overspending: The quick access to funds may lead you to spend beyond your means and end up in debt.
How revolving accounts affect your credit
Revolving credit accounts can have a positive or negative effect on your credit score, depending on how you use them.
Specifically, revolving credit can affect your score in the following ways:
Monthly billing cycles mean a high risk of missing a payment
You’ll need to make payments toward your revolving credit account each month, and this can easily lead to missed payments if you’re not careful. Payment history is the biggest factor that affects your credit score, so paying your bills on time should be a top priority if you want a good credit score.
Increased spending raises your credit utilization rate
Seeing your credit limit increase can make it tempting to spend more money—but making too many major purchases in a short time will increase your credit utilization rate and cause your credit score to drop. A high utilization rate hurts your score because credit bureaus consider it a sign of financial instability.
To avoid lowering your credit score, you should keep your revolving utilization rate as low as possible and never let it reach 30%. You should also avoid closing old revolving accounts, even if you’re not currently using them, since closing accounts reduces your total available credit (thus increasing your total credit utilization rate).
Revolving accounts affect the length of your credit history
The length of your credit history is one of the major factors that influence your credit score. Opening a credit card hurts your credit score in the short term by reducing the average age of your accounts and triggering a hard inquiry.
However, if you use them responsibly, revolving credit accounts benefit your credit score in the long term by increasing your total available credit and allowing you to build a positive payment history.
Revolving credit improves your overall credit mix
Another factor that influences your credit score is your credit mix (the variety of different accounts you have). Although credit mix isn’t as important as the other factors considered by the major credit scoring models, demonstrating that you can responsibly manage both installment and revolving accounts can give your credit score a boost.
