Revolving credit can help boost your credit score, but it can also create a spending trap (2023)

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  • 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.
  • Compared to installment loans, such as mortgages or auto loans, revolving credit accounts typically come with higher interest rates.
  • 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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There are three types of credit: open credit, installment loans, and revolving credit.

Installment loans are often large sums of money borrowed at once that you pay off over a period of time in relatively small quantities. These are often used for milestone purchases such as a house or a car. Open credit allows you to borrow up to a certain limit, but the entire amount must be paid off at the end of a billing period. These are often used for reoccurring bills, like utility bills or phone bills.

But for everything in the middle, you have revolving credit. Revolving credit lets you make purchases when you don't have the cash on hand. Here's how it works:

What is revolving credit?

Revolving credit lets you borrow money up to a certain limit whenever you want. Every time you make a purchase, the amount is subtracted from your total credit limit. As you make payments, your credit limit goes back up, so you can turn around and 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.

Lines of credit are another example of revolving credit. Personal and home-equity lines of credit (HELOC) are common choices for those who need to borrow large amounts of money on a flexible schedule.

Revolving credit offers greater flexibility than other types of credit. They don't come with fixed monthly payments or pay-off dates like loans, though you will have minimum monthly payments. 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.

Types of revolving credit

Revolving credit comes in two types: unsecured and secured credit.

Secured credit is credit backed by collateral, such as a security deposit or property like a car or a house. Your borrowing limit in secured revolving credit is proportional to whatever you put up for collateral.

This is less of a risk for lenders since they will be compensated if you can't pay back your debts. Because there's less risk, your interest rate under secured credit will typically be lower. A common example of secured revolving credit is a secured credit card.

On the other hand, unsecured revolving credit isn't backed by anything. While you as a borrower won't be at risk of losing anything if you don't pay your debts, your interest rates will be higher. Most traditional credit cards are forms of unsecured revolving credit.

Pros and cons of revolving credit

Just like all financial products, revolving credit accounts come with their benefits and its drawbacks.

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. Interest can become very problematic if you don't pay your account 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.

How does revolving credit affect your credit score?

When calculating your credit scoring from your credit report, both FICO and VantageScore, the two most popular credit scoring models, factor types of credit into your overall score. Your mix of credit accounts makes up 10% of your FICO score while VantageScore groups types of credit and length of credit under one category, making up 21% of scores.

What this means is that lenders like to see that you can keep multiple types of credit in check, similar to how colleges like students who can balance academics and a sport or other extracurriculars. For example, you may have student loans and an auto loan that you're already on top of. If you can add a credit card to this mix and pay it off regularly, that may improve your credit score. In a lender's eyes, you become a safer bet when they let you borrow money.

Revolving credit also comes into play when you look at credit utilization, which makes up 30% of FICO scores and 21% of VantageScore calculations. Credit utilization is the ratio of the credit you are currently using to your total available credit. This should stay under 30%, though the lower you can get your utilization ratio, the better.

The latest models of both VantageScore and FICO, 4.0 and 10T respectively, account for trended credit data. Trended data is a method of predicting future behavior by looking at past data. In the case of credit, this means looking at balances on your revolving credit accounts for the past 24 months to predict how you'll make future payments.

How to use revolving credit

Revolving credit can be a useful financial tool to build your credit history, 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.

Anna Baluch

Freelance Writer

Anna Baluch is a freelance writer from sunny Cleveland, Ohio. She enjoys writing about mortgages, debt relief, retirement, and more. Connect with her onLinkedIn.

Paul Kim

Associate Editor at Personal Finance Insider

Paul Kim is an associate editor at Personal Finance Insider. He edits and writes articles on all things related to credit.When he's not writing, Paul loves cooking and eating. He hates cilantro.

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