Revolving credit can help boost your credit score, but it can also create a spending trap
- The term "revolving credit" refers to things like credit cards and lines of credit - it's money you can borrow, pay back, then borrow again.
- Revolving credit typically comes with a higher interest rate than an installment loan, such as a mortgage or an auto loan.
- It can be easy to spend more than you can afford with a revolving credit account, so managing your spending and paying off your debt in full every month is key.
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You need to make a major purchase, such as a new computer or a big piece of furniture, but you don't quite have the cash on hand - so what are your options? The mostly likely choice is some sort of revolving credit account.
What is revolving credit?
Revolving credit gives you the chance to borrow money up to a certain limit. Every time you make a purchase, the amount is subtracted from your total credit limit. And every time you make a payment, your credit limit increases so you can borrow more.
The most common example of revolving credit is a credit card. If you have a credit card with a $10,000 credit limit and you make a $2,000 purchase, you only have $8,000 left to spend. Once you pay back the $2,000, though, your limit will be back up to $10,000.
Retail cards are another example of revolving credit - for instance, you may have opened a Best Buy card to purchase an electronic device and paid it off during the 0% interest rate period. You still have revolving credit with Best Buy on your retail card, even if you never use it again.
Lines of credit are another example; personal and home-equity lines of credit are common choices for those who need to borrow large amounts of money on a flexible schedule.
Unlike loans, revolving credit accounts don't come with fixed monthly payments or pay-off dates. While you can repay your entire balance at once, you don't have to. However, keep in mind that if you choose not to, you'll be charged interest.
Just like all financial products, revolving credit accounts come with pros and cons.
Pros of revolving credit
- The ability to spend what you need. If you have a credit card with a $10,000 credit limit, you don't have to spend that entire $10,000 if you don't want to. You can spend as little or as much as you need.
- Control how you repay your account. You can choose to pay off your account in full every month, or you can pay only the minimum balance or any amount in between (though you'll pay interest).
- A long-lasting source of credit. With a credit card or another revolving credit account, you won't have to apply for a new amount every time you need money, like you would with a loan.
Cons of revolving credit
- Higher interest rates. Revolving credit accounts typically come with higher interest rates than loans. This can be very problematic if you don't pay them in full every month.
- Fees. Some revolving credit accounts require you to pay annual fees, origination fees, or other fees.
- Debt and a damaged credit score. If you don't repay your accounts on time and in full and spend more than you can afford, you could end up in debt with a damaged credit score.
Revolving credit can be a useful financial tool, if you use it properly. To avoid getting into trouble with revolving credit, follow these tips.
Control your spending
If you have access to a large credit limit, it can be tempting to live life to the fullest and spend more than you can afford - but avoid that impulse.
Use revolving credit responsibly by only charging what you can pay in full every month. That allows you to take advantage of rewards and points on credit cards and boost your credit score without going into debt.
Pay more than your minimum payments
Getting into the habit of only making minimum payments can lead to a cycle of debt, since you'll have to pay a great deal of money in interest. Make an effort to pay your balance off in full every month. If you can't afford to pay the full balance, paying more than the minimum can at least help you save on interest.
Depending on how you use it, revolving credit can be your best friend or your worst enemy. To stay out of debt and keep your credit score in tip-top shape, be extra careful any time you use a credit card, retail card, line of credit, or another form of revolving credit.
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