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You’ve probably heard the term “revolving credit” before. But have you ever stopped to wonder: What does revolving credit mean? What is revolving credit and how does a revolving account work? Are revolving accounts different from other types of credit?
Keep reading to learn the answers to these questions and more.
When it comes to the types of accounts which appear on your credit reports, there are two major categories — installment and revolving.
Installment loans describe types of financing where you borrow money from a lender one, single time. The borrowed funds are typically paid back at a fixed amount over a fixed period of time. Installment debts include accounts like your mortgage, auto loans, student loans, and personal loans.
Revolving accounts, on the other hand, allow you to borrow funds over and over again, up to an approved maximum amount. This max amount, known as your credit limit, is set by your lender. However, you decide how much money you will borrow (aka charge) and how much you will pay back each month, aside from any minimum payment requirements.
Four of the most common revolving credit accounts are as follows:
When you use a portion of your revolving line of credit, you increase your balance on the account. At the same time, you reduce the amount of your available credit.
Here are a few examples of ways you might access the funds available to you on a revolving account.
At the same time, the balance you owe can increase (and your available credit may be reduced) when your lender tacks on interest and/or fees to your account.
You can reduce your revolving balance by making credit card payments. When you pay down a portion of your balance with your monthly payment, that amount will be added back to your available credit. Pay off all of the funds you borrowed (plus any applicable interest and fees charged by your lender) and you’ll be free to borrow up to your limit again.
When managed properly, revolving credit accounts can offer you some great benefits. Here are five ways that a revolving account, like a credit card, could work to your advantage.
You shouldn’t consider the perks revolving accounts can offer without also considering the cons. The following list describes the potential downsides to using revolving accounts.
The good thing about the cons listed above is they are all avoidable. You’ll only have to worry about these negative side effects if you fail to manage your accounts properly.
If you don’t pay off your credit card balance in full by the due date, the result will be an outstanding balance which is revolved from one month to the next.
Credit cards charge interest fees, also known as finance charges, when this happens (unless you have a 0% promotional offer on your account). Additionally, your credit scores might be impacted in a negative way.
Here’s a look at how revolving a balance on your credit card works.
So in this case you’re revolving a balance of $1,940, and accruing quite a bit of interest. This is why we always recommend paying your statement balance in full, rather than just the minimum payment (unless you have a 0% promotional APR).
On revolving accounts, you can choose whether to pay off your full balance each month or to roll over a portion of your balance (minus at least the minimum payment) to the following month. Carrying a balance from one month to the next is known as revolving the debt.
Your lender may allow you to roll an outstanding balance from one month to the next, but doing so probably isn’t the best choice for your credit scores or your wallet.
Credit scoring models like FICO and VantageScore are designed to pay attention to something known as your revolving utilization ratios, especially on your credit card accounts. Credit card utilization is one of the most predictive measurements in both FICO and VantageScore’s scoring systems. In fact, your revolving utilization ratios on credit cards are largely responsible for 30% of your FICO Scores.
You can learn more about the specifics of how revolving utilization works here. However, as a rule of thumb, lower credit card balances lead to lower revolving utilization ratios. Lower revolving utilization ratios on credit cards are better for your credit scores (except in one odd circumstance).
Although credit scoring models may consider your utilization on lines of credit and HELOCs, modern scoring models can tell the difference between these revolving debts and your revolving credit card accounts. As a result, a maxed out home equity loan probably isn’t going to have the same negative impact upon your credit scores that a maxed out credit card could have.
When it comes to revolving debt, the most important action you can take is to keep your payments on time. Payment history is the most important factor considered when your credit scores are calculated, and it’s one of the hardest to remedy if you slip up.
When it comes to revolving credit card accounts specifically, keeping your balances low is a smart strategy as well. If you aren’t paying your statement balances in full each month and you’re looking for an actionable way to give your credit scores a quick boost, it’s probably a good idea to start chipping away at your outstanding credit card debt. If you’re already paying your full statement balance and still have high utilization, you could pay off part of your balance early each month (before the statement is generated) or request a credit limit increase.
Paying down credit card debt has the potential to both boost your credit scores and save you some money in interest fees at the same time.
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