Revolving credit is a specific type of line of credit. Both are financing arrangements made between a lending institution and a business or an individual. The lender provides access to funds that the borrower can use at his discretion; it's like a flexible, open-ended loan.
Revolving credit is very similar to a credit card; in fact, some institutions refer to a revolving credit agreement as a revolving line of credit. The lending institution grants you a maximum credit limit, which you can use to make purchases at any time and (usually) on any goods. Many small business owners and corporations use revolving credit to finance capital expansion or as a safeguard in the event of cash flow problems. Individuals might use it for overdraft protection on demand deposit or checking accounts or to cover large, ongoing expenses, like house renovations or medical bills.
If you make regular, consistent payments on a revolving credit account, the lender may agree to increase your maximum credit limit – again, like a credit card. 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 for borrowing again. The credit limit may be used repeatedly as long as you do not exceed the maximum.
Non-revolving lines of credit have the same features as revolving credit (or revolving line of 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. There is one major exception: The pool of available credit does not replenish after payments are made. Once you pay off the line of credit in full, the account is closed and cannot be used again.
Revolving Credit vs. Line of Credit
Credit Lines Vs Loans
This is still different from other traditional loans. Most installment loans, such as 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. Traditional loans also come with set monthly payments, while most lines of credit do not. The payments on those tend to be more irregular, because (unlike a loan) you are not being lent a lump sum of money and charged interest right away. A line of credit is more the ability to borrow funds in the future up to a certain amount; you are not charged interest until you actually start tapping into the line for funds.
Like loans, however, both revolving credit and non-revolving lines of credit come in secured and unsecured versions. A secured credit is borrowed against a tangible asset, which serves as collateral; as a result, interest rates on secured credit accounts tend to be much lower than those on unsecured credit accounts. One very common form of a secured line of credit is a home equity line of credit, in which the lending institution allows you to borrow against the equity in your home or a second mortgage.
When a Line of Credit Is Not Useful
There are two features of lines of credit that make them particularly attractive: purchase flexibility and payment flexibility. Like a credit card, these can be used on an as-needed basis and paid off when it is convenient, depending on terms of the line of credit. A line of credit also comes with many of the same risks as credit cards.
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.
Federal regulations on education loans make lines of credit tricky for paying for college. Most financial institutions are not ready to approve open lines of credit for colleges. You probably receive a more attractive rate via a Federal Direct Student Loan or PLUS loan, anyway.
Before opening a line of credit (or a credit card), always consider whether it would be possible to alter your spending habits and budget more effectively instead of assuming more debt. There are financial and moral hazards associated with open-ended credit, no matter what form it takes.