Borrow, Spend, Repay, Repeat. If you use a credit card, you probably understand how revolving credit works.
Payday is a week away. You’ve got bills to pay. And your side hustle isn’t keeping enough coin in the coffer. If you’re looking for financial flexibility that caters to your lifestyle, consider a revolving line of credit.
What’s a revolving line of credit?
A revolving line of credit lets you tap into a set amount of money for an unlimited amount of time. You can use as much or as little of the money as you want, so long as you don’t exceed your credit limit, and the credit is renewed automatically once your debts are paid off.
Like a credit card, revolving credit is for you to use as you see fit. It could be to cover an unexpected cost, like an untimely car repair or a medical emergency, or maybe it’s just to cover a regular phone bill payment. Either way, it doesn’t matter. A revolving line of credit gives you the peace of mind that you can cover your bills — just know you’ll be charged interest until it’s repaid.
Here’s how it works: You’re offered a $5,000 revolving line of credit, and you use $2,000 to help make ends meet. You now have $3,000 remaining in revolving credit that can be used at any time, and you’re on the hook for any interest charges on the borrowed $2,000 until it’s repaid. Once you pay off the $2,000, your $5,000 revolving line of credit is restored.
Get it? The borrowing, spending and repaying happen in a continuous (one might say, “revolving”) loop.
How can revolving credit help me?
A revolving line of credit gives you the flexibility to spend as needed.
Unlike installment credit, which gives you a set amount of money and a repayment schedule over a set amount of time, revolving credit is open-ended. You can spend when you want, for as long as you want, without having to re-apply for a new loan. Best of all, with a revolving line of credit, you only pay interest on what you borrow.
Revolving credit also allows you to pay back the money you borrow at your leisure.
If you’re flush with cash, you can pay off your balance in full and restore your credit line. If money is tight, you can carry a balance and let your credit line bridge the gap until your finances improve.
The ability to pay off your balance at your own pace gives revolving credit a major edge over installment credit.
With installment credit, late payments — and even early payments (!) — can result in penalties.
If you pay off your installment credit before the term of the loan ends, you will often get hit with a prepayment penalty, sometimes called an exit fee. These fees exist because the loan may be packaged and sold in a security to another institution. A prepayment penalty is intended to stop you from failing to let your loan fulfill its yield.
A revolving line of credit also gives you the freedom to spend on what you want. Installment credit usually comes in the form of a loan and is for a specific purpose: a car, school tuition, even a mortgage. So if you’ve taken out a hefty student loan, that money can only be spent on education expenses. Revolving credit allows you to spend based on what you need most, even if that changes over time.
What’s the downside to revolving credit?
The very flexibility that makes a revolving line of credit an attractive option for many comes with its own drawbacks.
Sure, you can pay at your own pace and in the amount that best suits your needs. But if you fail to stay on top of your payments, or if you’re consistently getting hit with big interest charges, revolving credit can ultimately do more harm than good.
The interest rate for revolving credit is usually variable, rather than fixed, which means it’s subject to fluctuation. When interest rates are increased or decreased by the Federal Reserve, the interest rates on a revolving line of credit typically follow suit.
Bottom line: The flexibility of revolving credit is a valuable tool if your cash flow and expenses are regularly in flux. Each lender is different, so make sure to review your lender’s terms before getting a revolving line of credit. In the end, whether revolving credit is right for you comes down to your needs and your ability to manage it.