Have you ever wondered what the term “revolving credit” means, and how it differs from other forms of credit? Your credit card is one of several types of revolving credit that you may have, and it can help to understand exactly how these loans work.
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Revolving Credit: The Basics
Revolving credit is a type of loan that allows repeated access to funds, up to an approved credit limit. When you use a portion of your revolving credit line, you reduce the amount of your available credit, and typically increase the minimum payment required.
So long as you have an outstanding balance, you continue to make payments as required that can vary in size based on the amount you owe plus interest charges. Furthermore, you have the option to pay off the loan sooner by paying more than the minimum amount, or to pay off the loan entirely at any time.
How Revolving Credit Differs from Other Kinds of Credit
The other major type of credit is called an installment loan or close-ended loan. In contrast to revolving credit, an installment loan allows you to borrow a fixed amount of money and pay it back on a set schedule.
The date and amount of each payment is agreed upon at the time the money is borrowed. Some installment loans can be paid off early, while others can have a prepayment penalty. Common types of installment loans include home mortgages, car loans and student loans.
Types of Revolving Credit
The most common type of revolving credit is your credit card. You can have a credit card account open, and use it only when you need to. When you make charges to your credit card account, you will be required to make a minimum payment, which will depend on the amount borrowed. However, most credit card accounts will provide a grace period and will not charge interest if you pay your entire statement balance in full by the due date.
Another type of revolving credit is a store charge account. A store credit card works similarly to a regular credit card, but it can only be used for purchases at the store that offers it.
Finally, banks offer lines of credit that you can draw upon, such as home equity loans, and those for small businesses. With all of these types of revolving credit loans, borrowers can choose how much and when to borrow, and their payments will only reflect the amount they owe, plus interest.
Managing Your Revolving Credit Account
Revolving credit offers a more flexible way to borrow money than installment accounts, but this flexibility can sometimes be a drawback.
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When borrowers continue to make just the minimum payment, it can take many years to pay off the entire loan. And if borrowers continue to make new charges to their revolving line of credit, they will keep incurring interest charges and must make monthly payments until the balance is paid off.
By understanding what revolving credit is, and how it works, you can make the best use of this valuable financial tool.