Revolving Credit vs. Line of Credit: An Overview
Revolving credit and a line of credit are two types of financing arrangements available to businesses and individuals that provide borrowers with flexibility. A lender provides funds—up to a certain credit limit—that can be used and paid back at the borrower's discretion.
Though revolving credit and lines of credit have similarities, there are some differences. Revolving credit remains open until the lender or borrower closes the account. A non-revolving line of credit, on the other hand, is a one-time arrangement, and when the credit line is paid off, the lender closes the account.
- Revolving credit and lines of credit offer borrowers more flexibility than traditional loans.
- Borrowers can use revolving credit and repay it over and over again up to a certain credit limit.
- A non-revolving line of credit is a one-time financial arrangement that is closed when the borrower spends the set amount of credit.
When a lender issues revolving credit, it assigns the borrower a specific credit limit. This limit is based on the client's credit score, income, and credit history. When the account opens, the borrower is able to use and reuse it at their discretion. The account remains open until either the lender or the borrower decides to close it.
When payments are made on the revolving credit account, those funds become available to borrow again. The credit limit may be used repeatedly as long as you do not exceed the credit limit.
Many small business owners and corporations use revolving credit to finance capital expansion or as a safeguard to prevent future cash flow problems. Individuals can use revolving credit for major purchases and ongoing expenses, such as house renovations.
If you make regular, consistent payments on a revolving credit account, the lender may agree to increase your maximum credit limit. There is no set monthly payment with revolving credit accounts, but interest accrues as it would for any other form of credit. Borrowers owe interest on the amount they draw, not on the entire credit line.
If you don't manage revolving credit and credit lines prudently, it can be a risky way to borrow. A significant part of your credit score (30%) is your credit utilization rate. Most credit experts recommend keeping this rate at 30% or below so it doesn't have a negative impact on your credit score.
Line of Credit
Non-revolving lines of credit have the same features revolving credit does. A credit limit is established and funds can be used for a variety of purposes.
That said, there is one major difference between the two. The pool of available credit does not replenish after payments are made. So when you use a non-revolving line of credit and pay it off in full, the account is closed and can no longer be used.
Revolving Credit vs. Line of Credit
Revolving Credit vs. Line of Credit Examples
Credit cards are the most common form of revolving credit. Borrowers are assigned a credit limit—the maximum amount they can spend on their cards. Borrowers can use their cards up to this limit and make payments—whether that's the minimum payment due or the balance in full—and reuse that amount when it becomes available.
Credit lines can be non-revolving and revolving. An example of a non-revolving line of credit is a personal line of credit offered by a bank in the form of an overdraft protection plan. A banking customer can sign up to have an overdraft plan linked to their checking account. If the customer's balance dips below zero, the overdraft keeps them from bouncing a check or having a purchase declined. Like any line of credit, an overdraft must be paid back, with interest.
A home equity line of credit (HELOC) is an example of a revolving credit line. A preapproved amount of credit is extended based on the value of the borrower's home. The funds in the account can be accessed in various ways, via check, a credit card connected to the account, or by transferring funds from one account to another. You only pay interest on the money you use, and the account offers flexibility to draw on the line of credit when needed.
Both revolving credit and lines of credit come in secured and unsecured versions. Secured credit is borrowed against a tangible asset, such as a house in the case of a HELOC, which serves as collateral. Interest rates on secured credit lines tend to be much lower than those on unsecured credit accounts because they present less risk for the lender.
Unsecured lines of credit are usually not your best option if you need to borrow a lot of money. If you plan to make a one-time purchase, consider a personal loan instead of a line of credit. Loans tailored to a specific purchase, such as a home or a car, are often good alternatives to opening a line of credit.
How Lines of Credit Differ From Traditional Loans
Both revolving credit and lines of credit are different from traditional loans. Most installment loans—mortgages, auto loans, or student loans—have specific purchasing purposes in mind. You must tell the lender what you are going to use the money for ahead of time and, unlike with a line of credit or revolving credit, you may not deviate from that.
Line of credit payments tend to be more irregular. Unlike with a loan, you are not being lent a lump sum of money and charged interest right away. A line of credit allows you to borrow funds in the future up to a certain amount. This means you are not charged interest until you actually start tapping into the line for funds.