Understanding the differences between revolving credit and lines of credit can significantly impact your financial management strategy. Both forms of credit offer flexibility, but they are designed for different purposes and come with distinct terms and conditions.
Revolving Credit
Revolving credit is a type of credit that allows you to borrow, repay, and borrow again up to a certain credit limit. One of the most common forms of revolving credit is a credit card. When a lender issues revolving credit, they set a credit limit based on factors such as your credit score, income, and credit history. This limit represents the maximum amount you can borrow at any given time.
A revolving credit account is considered to be open until either the lender or the borrower decides to close it. A line of credit, on the other hand, may have a termination date or terms that stipulate a period of time during which you are permitted to make payments but were not permitted to withdraw money. You are able to continue to use and repay the credit for an infinite amount of time as long as you continue to make the required minimum payments and do not go over your credit limit.
One significant advantage of revolving credit is its flexibility. You can use it for various purposes, from everyday purchases to major expenses. For instance, if you have a credit card with a $5,000 limit, you can use it to pay for groceries, utility bills, or even a vacation. As you make payments, the amount you repay becomes available to borrow again.
However, it is essential to manage revolving credit responsibly. High balances and late payments can negatively impact your credit score. "A significant part of your credit score (30%) is your credit utilization rate. Most credit experts recommend keeping this rate at 30% or below so it doesn't have a negative impact on your credit score".
Line of Credit
A line of credit, on the other hand, provides you with access to a set amount of funds that you can draw from as needed. Unlike revolving credit, a line of credit may have specific terms regarding repayment and availability. Lines of credit are often used for larger projects or expenses where the total cost is uncertain, such as home renovations or business expenses.
There are two main types of lines of credit: revolving and non-revolving. A revolving line of credit, such as a home equity line of credit (HELOC), allows you to borrow, repay, and borrow again within the credit limit. A non-revolving line of credit, however, does not replenish after repayment. Once you pay off the borrowed amount, the account is closed.
In the realm of revolving credit lines, one example is a home equity line of credit, sometimes known as a HELOC. In accordance with the borrower's equity, a predetermined amount of credit is granted to the borrower. The money that is held in the account can be accessed in a number of different ways, including through the use of a check, a credit card that is linked to the account, or by the transfer of money from one account to another.
Lines of credit can be secured or unsecured. A secured line of credit is backed by collateral, such as your home in the case of a HELOC, which generally results in lower interest rates. Unsecured lines of credit, on the other hand, do not require collateral but may come with higher interest rates due to the increased risk for the lender.
Key Differences
The primary difference between revolving credit and a line of credit lies in their structure and usage. Revolving credit is typically used for smaller, everyday purchases and offers continuous access to funds as long as you make minimum payments. In contrast, a line of credit is often used for larger, irregular expenses and may have specific terms for repayment and availability.
Another critical distinction is the impact on your credit score. While both types of credit can affect your credit score, revolving credit has a more direct impact due to the credit utilization rate. Keeping your utilization rate below 30% is crucial for maintaining a healthy credit score.
