Credit 101
What to understand and watch out for
If you’re considering borrowing money for a home repair project, special getaway, or some other big purchase, you may have heard about revolving credit. This type of credit is commonly used by many consumers, but what does it involve? Here are the facts on revolving credit and how it can affect your credit score either positively or negatively.
Unlike a traditional loan, revolving credit is a set amount of credit you can borrow against time and time again. If you have a revolving credit limit of$1,000, for example, you can choose to borrow the entire $1,000 and pay it back over time or in one lump sum. You could also borrow just $50 or even $200 and pay it back according to the terms of your credit agreement.
Revolving credit is unique in that you can keep borrowing new amounts even if you haven’t paid off the old debt in full. As long as you don’t go over your total credit limit, you can keep accessing the amount extended to you.
Why is it called “revolving”? You’ll get a bill for the total balance owed at the end of your current billing cycle. If you don’t pay off the full amount, the remaining debt will be carried over (or “revolved”) to the next billing cycle.
Here’s how you may use revolving credit in your daily life.
Not all revolving credit accounts work exactly the same, but some of the options you may have in accessing your credit include getting cash from your account through your bank or with a credit card at an ATM. It may be possible to advance money from your line of credit to another account, so that you’ll have the money you need to fund a purchase.
If you use up all of the credit available in your revolving credit account, you won’t be able to spend or charge more until you’ve paid off some of it. You won’t just be on the hook for the amount you borrowed, however. You will likely face interest charges and any fees applicable to your account, like cash advance fees fromATMs, for example.
Be sure to add up your purchases, transfers, fees, and interest to make sure you don’t go over your total credit line limit. If you do, you could be subject to even more fees. This is why it’s so important to know the interest rate and any associated fees with all types of credit.
Most revolving credit accounts require at least one payment per month, and the lender will send you a statement or bill to let you know the minimum payment and when it’s due. That doesn’t mean you can’t make more than one payment, though. You can also pay much more than the minimum owed. If you can pay for the full amount, you’ll probably end up paying less in overall interest. Every bit above the minimum will help you pay down your balance faster, even if you can’t afford to pay the entire thing down to $0.
Revolving credit may come with fees. Some of the most common fees for credit cards include annual fees, foreign transaction fees, and cash advance fees Home equity lines of credit (HELOC) may have other fees too[6], like closing costs and origination fees. Almost every kind of account will charge fees for paying late, going over your credit limit, or paying with a check that bounces or is returned as unpayable.
You’ve already learned how revolving credit gives you access to a set amount of credit that you can borrow and pay back again and again. Non-revolving loans give you a set amount of funds that you have to pay back until the entire loan is paid off.Generally, you cannot continue to borrow against a non-revolving loan.
When the debt is paid, the account is closed, and you’ll have to apply for another loan to access funds again. Student loans and most traditional mortgage loans are good examples of this type of credit, as are personal loans and auto loans.
How you manage revolving credit can push your credit score higher or lower. Let’s look at some examples.
Do you pay your revolving credit account bills on time? Are you consistently doing this each and every month? If so, the credit bureaus will get this information and use it to calculate your credit score. Payment history is typically a big factor in determining your score, with the amount of on-time, missed, and/or late payments taken into account.
Since you can borrow and pay back a revolving line of credit over and over, it can really influence your amounts owed. Specifically, it can affect your credit utilization rate, which is the amount of money you owe divided by the total amount of your credit limits. Try to keep this number under 30% to help maintain a healthy credit score.
An example would be a $10,000 revolving credit line where you only borrow $2,000. This is well under the 30% ratio, since $2,000 divided by $10,000 is 20%. Apply this same principle to all of your credit accounts.
Another factor that determines your overall credit score is your history and the"newness" of your credit. If you have too many brand-new accounts and not very many long-time, established accounts, lenders may not have enough history to determine your creditworthiness. Having older accounts definitely helps.
Likewise, opening up too many accounts within a very short window can drop your score and may cause a lender to think that something is wrong with your personal financial situation. Why else would you be applying for a bunch of credit cards or loans at once? It’s best to stagger out your applications.
Is it possible to be a well-rounded consumer? The credit agencies and lenders think so, which is why part of your credit score is determined by how balanced you are in having both revolving and non-revolving credit accounts. If you only have one type of account or the other, it could limit your ability to achieve the best credit score.
Whether revolving credit is "good" or "bad" is up to you. If used wisely, revolving credit can help you pay for expenses and fill in some funding gaps. Credit cards may also come with some perks like cash-back rewards or travel benefits, making them a smart way to purchase items. The Petal1 card, for instance, offers users 2%-10% cash back at select merchants.
Like any credit, however, misuse can cause you to fall deeper into financial trouble or even damage your credit report and lower your credit score.
Looking for strategies to help you use a revolving credit account for your financial future? Start with these:
Even if your credit line is only a few hundred dollars to start with, you should avoid spending all of it right away. A higher balance will have a larger minimum monthly payment amount and may be more difficult to pay off. It can also affect the utilization ratio we discussed earlier.
Try your best not to miss a payment. Late payments or underpayments can damage your credit score and may cause you to incur penalties. Fees can range from $29 to $40—or more. Also, try to pay off as much of your balance as you can reasonably afford
Even if you aren’t sure which revolving credit account is right for you, stick to applying for one at a time. Do your research, and when the time is right, allow that application to go through. What if you get denied? Just wait to see the reason for the denial before applying for another account. If you can, take time to correct any potential issues that may have prevented the first approval before you submit another application.
Finally, make sure you know how you can fit a revolving credit account into your existing budget and financial goals. Don’t consider it extra or free money; it’s a responsibility you will need to pay back. Track your spending and watch for patterns. If you see that you’re making unwise decisions with your account, such as buying frivolous items or racking up expensive fees, reassess the role of this account in your life.
Learning to manage one revolving credit account before you open another one just makes sense. Get in the habit of paying your bill on time every month, and try to keep your balances low.
This blog does not provide legal, financial, accounting or tax advice. The content on this blog is “as is” and carries no warranties.
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Whether you’re in the market for your first credit card, or your fifth, it’s best to go into the process with a plan.
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