A:

There are two main ways in which you can be granted credit: installment credit and revolving credit. Revolving credit accounts typically have a maximum credit limit that you can borrow from multiple times, as long as you do not exceed the limit. Installment loans have a targeted end date and strict payment schedules, but revolving credit accounts are much more flexible and open-ended. Generally speaking, it is best to use revolving credit when you want to build your credit score quickly, when you need to be able to borrow funds quickly for a variety of purposes and when you expect to have a borrowing need for an undetermined amount of time.

The two most common forms of revolving credit are credit cards and revolving lines of credit, such as a home equity line of credit (HELOC). Credit cards, which are unsecured, tend to have relatively high interest rates and relatively low maximum credit limits. If there are monthly minimum payment amounts, they tend to be small. When used correctly, credit cards are an extremely useful way to build your credit score. Your use of credit cards is very important when calculating your credit utilization ratio, which, according to the credit bureau Experian, makes up as much as 35% of your total credit score.

Home equity lines of credit are secured lines of credit that use a property as collateral. The terms of a home equity line of credit tend to be more favorable than terms for unsecured credit cards. However, the value of your home is at risk if you default on your loan obligation. Home equity lines of credit are useful if you are consistently embarking on fix-up projects around your home or if you expect that you will need to borrow modest sums of money periodically and do not want the high rates that come with credit cards.

Flexibility and credit score impact are two defining features of revolving credit lines. Some businesses use revolving lines of credit to allow for additional capital expansion or as a safety net in case of poor monthly cash flow. If you are self-employed or have a variable income, you can benefit from the security of a revolving credit account as long you use it responsibly. The danger in having access to easy cash is the temptation to over-borrow or practice bad saving habits.

There is a reason that most major debt items, such as mortgages, automobiles and student loans are made with installment loans and not revolving credit. It is risky to the lender and the borrower to have an extremely large and undefined credit limit. Many consumers get into trouble by opening too many forms of revolving credit at once. Pay attention to your revolving credit accounts and tend to them appropriately.

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