Chris Bridges, Founder and CEO, VITAL Card Inc.
Do you have many uncertain business expenses that often come up, but you aren’t sure of your next expected payment date? If so, you should get a line of credit. This article will tell you about revolving and non-revolving lines of credit.
Definition of “Revolving Line of Credit”
In a revolving line of credit (also known as open-end credit) you can carry over the balance or revolve it to the next month without reapplying for it.
Conversely, in a traditional line of credit, aka non-revolving line of credit, your total credit available does not replenish after you pay off your balance; that is, it is a one-time arrangement. Your account is shut down after you pay off your balance in full.
How Revolving Credit Works
A revolving line of credit allows customers to draw the required amount against a line of credit up to a limit set by the lender. The credit limit is the maximum amount you can spend from the account for a fixed amount of time, usually per month.
It allows you to borrow as much as you need, as many times as you need, as long as you have enough credit available for that time. At the end of each billing cycle, you can pay back the entire balance you owe the lender or carry forward some of the balance from one month to the next.
The amount you can borrow in the next month will be your credit limit minus the unpaid balance. Hence, depending on how much you pay back, you free up more of the total credit amount you can borrow.
Benefits of Revolving Credit
A revolving line of credit offers a more flexible source of financing than a traditional line of credit. It affords individuals and businesses the flexibility to finance coming expenses fluidly, and not have to rely only on a stable cash flow.
With revolving credit, you only have to make payments if you borrow the money against your credit line. Common examples of a revolving credit line are credit cards, home equity lines of credit (HELOCs), and personal lines of credit.
Even if you choose to revolve your balance, you will still have to make a minimum payment in each billing cycle, either a fixed fee or a percentage of your total balance. Depending on the type of revolving credit line, interest may be levied on the amount of unpaid balance that is carried forward to the following month.
There might also be additional charges, such as annual fees, one-time sign-up fees, and penalties for missed or late payments.
Types of Revolving Line of Credit
- Credit Cards
- Home Equity
There are multiple types of revolving lines of credit, for example, short-term and long-term, depending on the duration you want to borrow for, and why you are borrowing.
The most common types of revolving lines of credit are discussed below. Each has its specific use and terms and conditions that determine the interest, duration, and fees.
Credit cards are perhaps the most popular application of a revolving line of credit. These instruments, usually offered by financial institutions, allow you to make purchases that are then deducted from your credit limit. The outstanding amount must be paid back at the end of each credit cycle. Credit cards can be reissued constantly, thus offering long-term security.
Innovative credit cards such as VITAL also provide numerous other rewards, such as cash back offers. VITAL Card’s mission is to empower its users with income generation opportunities stemming from community building and responsible spending activities.
Home Equity Line of Credit (HELOC)
The equity you own on your home is the total value of your home minus the outstanding loan amount on your home. Hence, your equity in your home measures how much ownership you have.
In the home equity line of credit or HELOC, you can leverage this equity and offer it as collateral for your line of credit. The interest rate on HELOC is typically lower than other lines of credit as you offer your home as security.
Much like a credit card, the amount of credit available is replenished each time you pay. You can keep borrowing against HELOC till the draw period ends (usually ten years), after which your repayment period begins (usually 20 years).
This type of credit is a great option to use long-term or for significant expenses, such as paying off consolidated high-interest loans.
Personal (PLOC) and Business Lines of Credit (BLOC)
These types of lines of credit are typically an unsecured revolving credit account with a variable interest rate.
Like a credit card, you can withdraw funds when you require. However, PLOCs differ from credit cards in how the funds can be accessed or used. While credit card transactions can easily be performed with the card itself, PLOCs may require special checks or transfers.
Moreover, unlike credit cards, PLOCs are temporary and may soon expire, hindering your ability to get cash in an emergency, whereas credit cards can be reissued repeatedly, offering more security.
PLOCs and BLOCs are mostly used to manage daily cash flow issues, especially if your personal or business income sources are erratic. However, given that they are unsecured, they might not be an option for everyone. They are best suited for consumers and businesses with a strong credit history.
What is the Impact on Your Credit History?
Any kind of credit, not just revolving credit, will impact your credit history. Lenders typically request your credit file from the credit bureau, which comes in the form of a hard inquiry on your credit report. This inquiry could be the single biggest impact of a revolving line of credit on your credit history.
While these inquiries usually only stay on your record for a few months, they can be there for up to two years, which reduces your credit score.
Revolving lines of credit are open-ended, meaning they don’t have a fixed end date. Eventually, after your draw period is over and you clear your outstanding debt, or when you discontinue a credit card, your reliance on a singular source of credit can increase.
If your withdrawal needs do not reduce accordingly, it may increase your credit utilization ratio to above 30% on other sources of credit. Your credit utilization ratio is the ratio of credit in use to credit available on your account. Using more than 30% of your credit limit can harm your credit score. It’s recommended that you use only10-30% before making a payment, to keep your credit utilization ratio at a good balance.
Additionally, applying for several credit cards or lines of credit signals financial uncertainty, which can also adversely impact your credit score. However, having multiple sources of credit and making timely payments on them can demonstrate your ability to handle debt.
For example, getting a credit card while also paying back other debts such as a mortgage will improve your credit score. So, conversely, an advantage of a revolving line of credit is that it can diversify your credit mix.
How to Manage Revolving Credit
- Never max out your line of credit.
- Always pay back on time.
- Avoid credit application rejections.
How a revolving credit line impacts your credit score depends on you. You can use it to improve your credit score by being responsive and responsible.
Never Max Out Your Line of Credit
First, never max out your line of credit, whether it is a credit card, PLOC, or any other form of credit. Ideally, your credit utilization ratio should be under 30%. If you urgently need funds, try to increase your credit limit.
Increasing funds will increase the amount you can borrow while still keeping your overall ratio below 30%.
Alternatively, you can withdraw smaller amounts from different lines of credit to prevent putting too much pressure on one source.
Always Pay Back On Time
Second, always pay back on time. Paying late can severely worsen your credit score and result in penalties and late fees.
A U.S. News study surveyed hundreds of credit cards active in the U.S. and found the average maximum late payment fee to be a whopping $36. A late fee will only make the payback process more difficult and result in a deteriorating relationship with your lender.
Avoid Credit Application Rejections
Finally, avoid being rejected from your credit applications, which can also negatively impact your credit score.
Before applying for a new source of credit, ensure that you’ve taken steps to boost your credit score. Credit bureaus state that on-time payments are the first and most important step toward boosting your score.
Steps such as spacing out your applications for revolving lines of credit will lessen your rejection chances. Lenders look negatively at multiple applications within a short time span, and so pacing yourself with applications will look more favorable on your credit report.
If you’re considering signing up for a revolving line of credit, we invite you to try out VITAL. We are a company that pays you to share and spend responsibly.
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