When you are hit with an emergency expense, such as a flat tire (or two), a broken bone or a leaky roof, what do you do? You may reach for your credit card. These expenses are never ideal, but that’s what revolving credit is for.
On the other hand, when you take out student loans or a mortgage on a new house, that’s known as non-revolving credit. This type of credit is a lump sum, because you aren’t being extended a line of credit. Once you pay your balance, that account is closed.
Both types of credit serve different purposes, with varying interest rates, limits and terms. But understanding the differences between revolving and non-revolving credit is crucial to knowing which type to use in different financial situations.
What is revolving credit?
Revolving credit, or open-end credit, allows you to borrow money on an ongoing basis and then pay it back according to the terms of your loan. With revolving credit, you have a set credit limit, and as you revolve (or carry) a balance, you have a minimum payment you must pay month-to-month. The most common example of this is a credit card.
Revolving credit is sometimes referred to as open-end credit or credit lines, because you can literally access the available credit whenever you want. The most common examples of revolving credit include personal lines of credit, home equity lines of credit (HELOCs) and of course, credit cards. Credit cards and other revolving accounts are unsecured loans, meaning the lender doesn’t get a fixed asset if the borrower can’t repay the loan.
When you’re approved for a new credit card, for example, you’re extended a line of credit with a limit of say $5,000. That credit limit is yours to use in whatever way you want. As you make purchases with your credit card, you must make payments at the end of each billing cycle. As you make payments, you’re restoring your account to its original amount. So, if you spend $1,000 one month and you make a full payment at the end of the billing cycle, your credit limit is restored to its original amount.
How does revolving credit affect your credit score?
Like any type of credit, revolving credit accounts affect your credit score based on how you use that credit. Revolving credit, such as credit cards, can be a great way to build credit. When you get your first credit card, use it for everyday purchases and pay the bill in full at the end of the month, you are building good credit.
However, if you use your credit card recklessly, consistently maxing out your credit limit and only paying the minimum amount due, you are negatively impacting your credit score.
On time payments are the single most important factor when it comes to calculating your credit score, so as a best practice, always pay your bills on time and in full. If you find yourself in a bind and only able to pay the minimum amount, don’t fret. Pay the minimum amount on time and aim to keep your balance below 30 percent of your available credit. This is known as your credit utilization ratio — the percentage of revolving credit you have in relation to your total credit limits.
What is non-revolving credit?
Non-revolving credit is a term that applies to debt you pay back in one installment, such as a student loan, personal loan or mortgage. Unlike revolving debt, you are not continuously adding to the original amount of the debt. Once you pay off the loan, you no longer owe the creditor.
With any type of loan that is considered non-revolving credit, you agree to an interest rate and a fixed repayment schedule upon borrowing the money. Interest rates tend to be lower compared to revolving credit. This is largely due to the fact that lenders are taking less of a risk, as the loan is tied to collateral they can seize if you default on your payments.
Revolving credit vs. non-revolving credit
Which is better, revolving credit or non-revolving credit? It depends on your situation.
In the case of revolving credit versus non-revolving credit, you really need to nail down what you’re seeking financing for. Do you need a large sum of money for one single purchase, or are you looking to step away from your debit card for everyday purchases? You don’t want to take out a personal loan for your grocery expenses each month. And you should probably avoid taking out a credit card to pay off your student loans.
There are a few key distinctions between revolving credit and non-revolving credit to keep in mind. For starters, revolving credit is designed to be more flexible, and can be used for a variety of purchases as long as you stick to your credit terms.
Non-revolving credit tends to be used for a single purpose, such as a car loan or student loan, and often comes with lower interest rates and steady repayment schedules.
For both types of credit, you have to submit an application in order to receive a line of credit. However, a line of revolving credit requires just one application. If you want to open another non-revolving line of credit, after paying off your balance on an existing one, you have to submit another application. And there’s no guarantee that you’ll be offered the same terms or interest rate.
You may get more purchasing power with non-revolving credit because consumers can get approved for higher amounts depending on your credit score and other factors. Can you pay for your new house or car with a credit card? Technically, yes. But it’s probably a bad idea. That’s where non-revolving credit comes into play.
Credit card issuers and banks consider the risk when lending revolving lines of credit to consumers. Because of this, banks tend to limit the amount of credit you can borrow. As a rule of thumb, if you only want to borrow money once, non-revolving credit is for you. If you want to borrow money several times, consider revolving credit.
The bottom line
The difference between revolving and non-revolving credit is an important distinction to make when trying to pinpoint what type of credit you may need in different financial situations.
Revolving credit products, such as today’s best credit cards, can be helpful while building credit, but they can also be dangerous if not used carefully. Non-revolving credit products, such as student loans or mortgages, are generally more stable but they can also be difficult to pay off. Make sure you choose the option that’s best for you, by carefully considering exactly what you need or want out of a new line of credit.