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What Is Revolving Credit?

Understanding the different types of revolving credit and how they work can help you manage personal finances, especially cash flow, with more flexibility.

By Karen Lynch | American Express Credit Intel Freelance Contributor

5 Min Read | August 4, 2021 in Credit Score

 

At-A-Glance

With revolving credit, you gain flexibility in your personal finances because you decide how much, and when, you borrow and spend as long as you stay within a preset credit limit.

Credit cards and lines of credit are the main forms of revolving credit.

If “revolving credit” is one of those financial terms that makes your head spin, it shouldn’t. Chances are, you’ve already used it more than once: It’s how credit cards work, after all.

 

In fact, most revolving credit involves credit cards. About two-thirds of actively used credit card accounts generally carry a revolving balance, according to the Consumer Financial Protection Bureau (CFPB).1  But banks and fintechs also offer home equity lines of credit and personal lines of credit based on revolving credit. This article describes how revolving credit works for each of these financial tools.

 

Understanding Revolving Credit: Credit Cards

Basically, a credit card company agrees to let you borrow money up to a certain limit, and you spend down that limit when you buy something with your card – for more detail, read “How to Increase Your Credit Limit.” Every month, you hit the reset button if you replace the money you’ve spent – aka paying your credit card bill. And then you’re back where you started: able to borrow up to your limit again. If you don’t replace what you’ve spent, you carry an unpaid balance into the next month – known as “revolving the balance” – and begin paying interest on this debt.


Credit cards serve different purposes at different times, the U.S. Federal Reserve has found. “For people who pay their balances off each month, credit cards are mainly a form of payment convenience and can be thought of more or less the same as using cash,” it stated in a report. “For those who carry a balance, however, use of the card represents borrowing and carries a cost in the interest payment and any fees that are incurred.”


Credit card bills are expected to be paid in full or in part every month – see “How and When to Pay Your Credit Card Bill.” Of the 83% of adults with credit cards, nearly half pay their credit card bill in full every month, according to the Fed. A quarter said they carried a balance for at least a while during the previous year, and another quarter said they usually or always carried a balance.3 The average interest rate on balances stood at 16.30% as of May 2021.4

 

Understanding Revolving Credit: Lines of Credit

The big difference between home equity and personal lines of credit is right there in their names. The first requires you to put up your home as collateral, and the second usually requires no collateral. Both set a credit limit against which you can borrow as needs arise. And both are often used to manage cash flow, though home equity lines are often used for major home improvements, too.

Home equity line of credit: In early 2020, people had more than $900 billion in home equity lines of credit to tap into. But they had used only about two-fifths of the funds available to them. As of mid 2021, the average interest rate on a home equity line of credit was just over 4%, ranging from about 2% to 7%, depending on the borrower’s credit profile and other factors.5 Often, you can make interest-only payments for a period of time and then begin paying the principal plus interest. Online calculators can help you work out the costs of a home equity line of credit.

Personal line of credit: While you don’t typically need to put up collateral for a personal line of credit, you do need a solid credit profile. With an average interest rate of around 6% as of mid 2021, personal lines of credit are usually more expensive than home equity lines of credit but less costly than some other forms of borrowing, such as cash advances on credit cards.6 To avoid confusion between personal loans (installment loans) and personal lines of credit (revolving credit), there are a couple distinctions to remember. Personal loans provide you with money in one lump sum, at a lower interest rate, and then require fixed, regular payments. Personal lines of credit tend to have higher interest rates than personal loans, but you’re only paying interest on the amount of money you actually borrow against your credit limit. And the payment plan resembles the one used for credit card bills, including monthly minimum payments based only on what you’ve borrowed.

 

What Is the Difference Between Revolving Credit and Installment Loans?

The other way people mainly borrow money – that doesn’t “revolve” – is with installment loans, such as mortgages, car loans, student loans, and personal loans. In the table below, we detail the differences between revolving credit and installment loans. Primarily, revolving credit provides more flexible access to funds as you need them, with monthly payments that vary as your level of borrowing changes and as national interest rates rise and fall. Installment loans are primarily taken out for big-ticket items and, as their name implies, usually repaid in regular monthly sums at fixed interest rates.

 

Revolving Credit Vs. Installment Loans
Credit Loans

Mainly used for making small- to medium-sized purchases and managing cash flow

Mainly for big purchases, such as a home, car, or college tuition

Varying monthly payments

Same payment every month

Typically higher interest rates

Comparatively lower interest rates

Usually easier to apply and qualify

Usually more paperwork and harder to qualify

 

Revolving Credit in America, By the Numbers

Revolving credit is a very big deal, as you can see in these statistics from various Fed reports:

  • Americans held about $1.3 trillion in revolving debt in early 2020 – most of it credit card debt.7
  • Americans carry more than 500 million credit cards; many people have more than one.
  • The total of all revolving credit limits in America came to $3.93 trillion in early 2020. Of that, unpaid balances amounted to $893 billion, leaving about $3.04 trillion available for spending.9 
  • The second largest form of revolving credit, the home equity line of credit, was used by homeowners to borrow about $400 billion in early 2020.10 
  • Other personal lines of credit represent a smaller piece of the revolving credit pie.
  • Revolving credit was seen declining during the recent economic downturn as consumer spending dropped, but leveled out as the economy began to stabilize.11
  • The larger portion of total U.S. household debt, which stands at over $14 trillion, is in installment loans.12 

 

The Takeaway

Revolving credit is a staple of personal finance that provides cash flow flexibility. Two main types of revolving credit are credit cards – used typically for everyday purchases – and lines of credit – used more often for cash flow management and home improvement. Understanding revolving credit and how it works can help you decide on the best financial tool for your needs.

Karen Lynch

Karen Lynch is a journalist who has covered global business, technology, finance, and related public policy issues for more than 30 years.

 

All Credit Intel content is written by freelance authors and commissioned and paid for by American Express. 

The material made available for you on this website, Credit Intel, is for informational purposes only and is not intended to provide legal, tax or financial advice. If you have questions, please consult your own professional legal, tax and financial advisors.