Revolving Credit vs. Line of Credit: An Overview
Revolving credit and line of credit (LOC) are two types of financing arrangements available to both business and personal clients. Both revolving and lines of credit provide the borrower with purchase flexibility and payment flexibility. These funds can be used at the borrower's discretion just like a flexible, open-ended loan. While these two facilities have some similarities, they are inherently different. A revolving credit product can be used—up to a certain credit limit—and paid down, and remains open until such time that the lender or borrower closes the account. A line of credit, on the other hand, is a one-time arrangement such that when the credit line is paid off, the lender closes the account.
- Revolving credit and lines of credit are facilities that offer the borrower purchase and payment flexibility.
- Borrowers can use revolving credit and repay it over and over again up to a certain credit limit.
- A line of credit is a one-time financial arrangement or a static product that is closed once the borrower spends the set amount of credit.
When a lender issues a revolving credit account, they assign the borrower a specific credit limit. This limit is based on the client's credit score, income, and credit history. Once the account is open, the borrower is able to use and reuse the account at their discretion. As such, the account remains open until either the lender or the borrower decide to close it.
Many small business owners and corporations use revolving credit to finance capital expansion or as a safeguard to prevent future cash flow problems. Individuals may use revolving credit for major purchases and ongoing expenses, like house renovations or medical bills. They may also use these facilities to cover account shortfalls in demand deposit accounts,
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 and is capitalized like any other credit. 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 maximum.
Line of Credit
Non-revolving lines of credit have the same features as revolving credit. A credit limit is established, funds can be used for a variety of purposes, interest is charged normally, and payments may be made at any time.
That being said, there is one major difference between the two. The pool of available credit does not replenish after payments are made. So once you use the 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
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 you may not deviate from that, unlike a line of credit or revolving credit.
Traditional loans also come with set monthly payments, while most lines of credit do not.
Line of credit payments tend to be more irregular. Unlike 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.
Like loans, both revolving credit and non-revolving lines of credit come in secured and unsecured versions. Secured credit is borrowed against a tangible asset, like a house or a car, which serves as collateral. As a result, interest rates on secured credit accounts tend to be much lower than those on unsecured credit accounts.
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.
Revolving Credit vs. Line of Credit Example
Credit cards are the most common forms 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.
Some lines of credit are revolving. For instance, a home equity line of credit (HELOC) is an example of a revolving credit line. A pre-approved amount of credit is given based on the value of the borrower's home, making it a secure type of credit. 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.
But not all lines of credit are revolving. Personal lines of credit are sometimes offered by banks 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.