What Is Revolving Credit? A Definition and How It Works

You’ve probably heard the term “revolving credit” before. But have you ever stopped to wonder: What does revolving credit mean? What is revolving credit and how does a revolving account work? Are revolving accounts different from other types of credit?

You may have used revolving credit without knowing the official term. In fact, you probably used it recently. If you’ve bought anything lately with a personal credit card – one that has a set credit limit but the credit can be repaid and used again – you’ve used revolving credit. 

There are different types of revolving credit such as credit cards and home equity lines of credit (HELOCs). Revolving credit can be good for borrowers to help manage expenses and build credit, but should be used responsibly.

Let’s explore how revolving credit works and some of its pros and cons.

What Is a Revolving Account?

A revolving account consists of revolving debt and revolving credit. It allows you to borrow funds over and over again up to an approved amount (revolving credit), while allowing you to roll over debt from month to month (revolving debt).

Your lender sets the maximum amount you can borrow, known as your credit limit. You can decide how much money you will borrow (aka charge) and how much you will pay back each month. Your lender won’t care how much you borrow as long as you stay below your credit limit and make your minimum payment requirements every month. 

Revolving Credit Examples

The four most common revolving credit accounts are:

• Credit cards
• Retail store credit cards
• Lines of credit
• Home equity lines of credit (HELOCs)

How Does Revolving Credit Work?

When you use a portion of your revolving line of credit, you increase your balance on the account. At the same time, you reduce the amount of your available credit.

Here are a few examples of ways you might access the funds available to you on a revolving account:

• Purchases/charges
• Cash advances
• Balance transfers

At the same time, your lender will usually charge you interest and/or fees based on how much credit you have used. And those charges will increase the balance you owe and reduce your available credit.

You can reduce your revolving balance by making regular credit card payments. When you pay down a portion of your balance with your monthly payment, that amount will be added back to your available credit.

Pay off all of the funds you borrowed (plus any applicable interest and fees your lender charged) and you’ll be free to borrow up to your limit again.

Pros of revolving accounts

When managed properly, revolving credit accounts can offer you some great benefits. Here are five ways that a revolving account, like a credit card, could work to your advantage.

• Helps you establish credit history
• Improves your mix of credit (a factor credit scoring models consider when calculating your scores)
• Gives you the freedom to borrow funds easily when you need them
• Provides better fraud protections than paying with cash or debit cards
• Offers you attractive rewards or cash back options

Cons of revolving accounts

It’s good to consider the perks revolving accounts can offer, but you need to also consider the drawbacks. Let’s look at some of the potential downsides to using revolving accounts.

• A poorly managed revolving credit account could damage your credit scores, which we’ll explore further below. 
• Revolving accounts, especially credit cards, often have high interest rates so carrying a balance can be expensive.
• If you mismanage another credit card or other credit account (e.g., start making late payments), your lender might choose to close your revolving account as a safety measure.

The upside to all the downsides listed above is they are all avoidable. You’ll only have to worry about these negative side effects if you fail to manage your accounts properly.

What Happens When You Revolve a Balance?

If you don’t pay off your credit card balance in full by the due date, the result will be an outstanding balance that revolves from one month to the next. This is considered revolving debt.

But there’s more to it than that. Credit cards charge interest fees (aka finance charges) on that outstanding balance, which increases the balance. And one more thing – your credit scores might be impacted in a negative way.

To get a better grip on things, here’s a look at how revolving a balance on your credit card works. Take a credit card with these figures as an example:

• Credit Limit: $2,000
• Beginning Credit Card Balance: $0
• Monthly Purchases: $540
• Payment Made on Due Date: $40 (minimum payment)
• Remaining Balance: $500
• Interest Charged at 19.99% APR: $8.33/month or $100 (approximately) if you kept the $500 balance for a full year.
  
  *Note: Actual interest fees will vary based upon your APR and daily balances.

In this case you’re revolving a balance of $500, and accruing quite a bit of interest. Also, the interest on the balance that you leave on the card compounds every month. This is why we always recommend paying your statement balance in full, rather than just the minimum payment.

Best Practices for Revolving Debt

Having revolving credit can be a good thing. Let’s look at a few circumstances and strategies to managing your revolving debt well.

• Establish credit:  If you don’t have credit established yet, consider getting a credit card to help you build credit. Only use it for small purchases and pay off the full balance each month to keep your credit utilization ratio low and help improve your credit score.
• Pay your balances: If you aren’t paying your statement balances in full each month and you’re looking for an actionable way to give your credit scores a quick boost, it’s probably a good idea to start chipping away at your outstanding credit card debt. 

Improve your utilization: If you’re already paying your full statement balance and still have high utilization, you could pay off part of your balance early each month (before the statement is generated) or request a credit limit increase.

Ultimately, when it comes to managing your revolving debt, the most important action you can take is to make your payments on time. Payment history is the most important factor considered when your credit scores are calculated, and it’s one of the hardest to remedy if you slip up.

Paying down credit card debt has the potential to both boost your credit scores and save you some money in interest fees at the same time.

How Does Revolving Credit Impact Your Credit Score?

Using revolving credit can either help or hurt your credit score depending on how you use it. 

Your lender may allow you to roll an outstanding balance from one month to the next, but doing so probably isn’t the best choice for your credit scores or your wallet.

Credit scoring models like FICO® and VantageScore® are designed to pay attention to something known as your revolving utilization ratios, especially on your credit card accounts. 

Credit utilization ratio is simply your revolving credit balance divided by your revolving credit limit. So in the example above where your balance was $500 and your limit was $2,000, your credit utilization ratio would be 0.25, or 25%. 

This is a good utilization ratio. Generally speaking, we advise keeping your ratio below 30% to improve your credit score. 

Credit card utilization is one of the most predictive measurements in both FICO’s® and VantageScore’s® scoring systems. In fact, your revolving utilization ratios on credit cards are largely responsible for 30% of your FICO® Scores.

As a rule of thumb, lower credit card balances lead to lower revolving utilization ratios. Lower revolving utilization ratios on credit cards are better for your credit scores. 

Although credit scoring models may consider your utilization on lines of credit and HELOCs, modern scoring models can tell the difference between these revolving debts and your revolving credit card accounts. 

As a result, a maxed out home equity loan probably isn’t going to have the same negative impact on your credit scores that a maxed out credit card could have.

What’s the Difference Between Installment Loans and Revolving Debt?

When it comes to the types of accounts that appear on your credit reports, there are two major categories — installment and revolving.

While revolving credit is a set debt limit you can repay and use time after time, installment loans describe types of financing where you borrow a set amount of money from a lender one, single time. 

You would pay back the borrowed funds at a fixed amount over a fixed period of time. Examples of installment credit include accounts like your mortgage, auto loans, student loans, and personal loans.

Use Revolving Credit Responsibly and Reap the Rewards 

Revolving credit is a great way to build your credit score and make purchases at a moment’s notice. Plus, credit cards may have attractive rewards or cash back options. 

But with all these perks comes responsibility. So, use your revolving credit wisely and enjoy the financial freedom it offers.