Definition
Revolving credit is a flexible method of borrowing money wherein a borrower has a maximum credit limit and can continuously borrow up to that limit whenever needed. Payments are made based on the amount that has been borrowed, not the total credit limit. Common examples include credit cards and personal lines of credit.
Phonetic
The phonetics of the keyword “Revolving Credit” is: /rɪˈvɑːlvɪŋ ˈkrɛdɪt/
Key Takeaways
Sure, here’s the information in HTML numbered list format:“`html
- Flexible Borrowing: Revolving credit is a flexible method of borrowing money. Unlike a fixed-term loan, it allows the cardholder to borrow as much as they want up to a predetermined limit. Once the borrowed amount is paid back, the user can borrow it again as needed.
- Interest and Fees: If the outstanding balance on revolving credit is not paid off in full each month, interest is charged on the remaining balance. In addition, there can be fees for late payment, cash advances, and sometimes annual fees.
- Impact on Credit Score: The utilization rate, or the ratio of the total credit card balances to the total credit limit, can significantly affect an individual’s credit score. It is typically recommended to keep this ratio below 30% to maintain a favorable credit score.
“`
Importance
Revolving credit is a crucial finance term because it refers to a type of credit that does not have a fixed number of payments in contrast to installment credit. Credit cards are one of the most common types of revolving credit account. It is significant because it provides individuals and businesses with constant access to funds, as long as they don’t exceed the maximum credit limit set by the lending institution. Consequently, it offers flexibility as borrowers only pay interest on the cash that they have borrowed, not on the entire credit limit. Therefore, revolving credit can be an essential tool for managing cash flow, enabling financial flexibility, and forming a part of a strategic financial management plan for individuals and businesses.
Explanation
Revolving credit is designed to provide flexibility and continual access to a line of credit for individual consumers or businesses. Unlike a traditional loan, where the borrower receives a lump sum and repays it over a certain time frame, revolving credit allows the borrower to draw, repay and redraw funds from an available credit limit as needed, much like a credit card. This ease of access to funding makes revolving credit a popular choice for those who may need variable amounts of credit or wish to smooth out their spending over periods of financial instability. It also provides much-needed immediate liquidity for unexpected expenses or opportunities.In the business context, these lines of credit can be used to cover day-to-day operational costs such as procurement of goods and services, and to fulfill the need for short-term capital. This can be particularly useful for businesses facing seasonality, fluctuating cash flows, or other unpredictable expenditures. By using revolving credits, companies thus gain the flexibility and control over their capital structure, being able to respond to changing market circumstances quickly. This kind of financial flexibility provided by revolving credits allows businesses to manage their cash flow, ensuring they can continue to operate and grow even in volatile markets.
Examples
1. Credit Cards: Perhaps the most common example of revolving credit is a credit card. Consumers are given a maximum credit limit, and they can make purchases up to that limit. At the end of the billing cycle, they can choose to pay off the balance in full or carry a balance to the next month. The remaining balance is subject to interest.2. Home Equity Lines of Credit (HELOC): A HELOC is a type of revolving credit where the homeowner borrows against the equity of his home. The homeowner can borrow as much or as little as needed within the draw period, usually up to 85% of the appraised value of the home. Similar to a credit card, whatever amount that’s not paid off at the end of the billing cycle will carry over to the next cycle with interest.3. Business Lines of Credit: Businesses can also have lines of credit with banks or other lenders. These lines can be used for various purposes, such as financing a new project, covering operating expenses during a slump, or taking advantage of a sudden opportunity. The business can borrow up to the credit limit, repay it, then borrow again as needed.
Frequently Asked Questions(FAQ)
What is revolving credit?
Revolving credit is a type of credit that does not have a fixed number of payments, unlike installment credit. It’s most commonly used with credit cards and home equity lines of credit (HELOCs).
How does revolving credit work?
With a revolving credit account, you’re given a maximum credit limit, and you can make charges up to that limit. Each month, you can carry a balance (or revolve the balance) from one month to the next, or you can choose to pay off the balance in full.
What happens if I exceed my credit limit on a revolving credit account?
If you exceed your credit limit, your credit issuer will likely charge you an over-the-limit fee. Your credit score might potentially be damaged as well.
How does revolving credit affect my credit score?
Responsible management of revolving credit can positively impact your credit score. However, maintaining high balances or maxing out your revolving credit can harm your credit score, primarily because it increases your credit utilization ratio – the amount of credit you’re using relative to your total available credit.
What’s the difference between revolving credit and a loan?
A loan provides you with a lump sum of money that you repay over a set term, while revolving credit is a credit line you can repeatedly use and pay back as long as the account is open and in good standing.
Is a revolving credit line the same as a credit card?
While both are forms of revolving credit and operate similarly, they are not the same. A credit card often has higher interest rates compared to other types of revolving credit lines, and they are structured differently in terms of repayment and fees.
How do I apply for revolving credit?
Applying for revolving credit is similar to applying for a loan or credit card. You would approach a bank, credit union, or other financial institution, complete an application, and await approval based on your creditworthiness.
Are there any drawbacks to using revolving credit?
The flexibility of revolving credit can potentially lead to overspending, accumulation of high-interest debt, and damage to your credit score if not managed effectively. It’s also common for revolving credit accounts to have variable interest rates, which can increase borrowing costs if rates rise.
Related Finance Terms
- Line of Credit
- Credit Limit
- Interest Rate
- Minimum Payment
- Annual Fee
Sources for More Information
