The difference between revolving and non-revolving credit
When you’re hit with an emergency expense, like a flat tire (or two), a broken bone, or a leaky roof, what do you do? You can apply 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 a student loan or a mortgage on a new house, it is called non-revolving credit. This type of credit is a lump sum, because you do not benefit from a line of credit. Once you pay your balance, this account is closed.
The two types of credit have 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 indefinite term credit, allows you to borrow money on an ongoing basis and then repay it according to the terms of your loan. With revolving credit, you have a set credit limit, and when you turn over (or carry) a balance, you have a minimum payment that you must pay month to month. The most common example is a credit card.
Revolving credit is sometimes called open-ended credit or lines of credit because you can literally access available credit whenever you want. The most common examples of revolving credit include personal lines of credit, home equity lines of credit (HELOC) and, of course, credit cards. Credit cards and other revolving accounts are unsecured loans, which means the lender does not get a lock-in if the borrower cannot repay the loan.
When you get approved for a new credit card, for example, you get a line of credit with a limit of $5,000, for example. You can use this credit limit as you see fit. Because you make purchases with your credit card, you must make payments at the end of each billing cycle. As you make payments, you will restore your account to its original amount. So if you spend $1,000 in a month and pay in full at the end of the billing cycle, your credit limit is reset 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, like credit cards, can be a great way to build credit. When you get your first credit card, use it for everyday purchases, and pay off the bill in full at the end of the month, you’re building good credit.
However, if you use your credit card recklessly, constantly maxing out your credit limit and only paying the minimum amount due, you negatively impact your credit score.
On-time payments are the 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 can only pay the minimum amount, don’t worry. Pay the minimum amount on time and aim to keep your balance below 30% of your available credit. This is called your credit utilization ratio – the percentage of revolving credit you have out of your total credit limits.
What is non-revolving credit?
Non-revolving credit is a term that applies to a debt that you pay off in one payment, such as a student loan, personal loan, or mortgage. Unlike revolving debt, you don’t continually add to the original amount of debt. Once you have repaid the loan, you no longer owe the creditor.
With any type of loan considered non-revolving credit, you agree to a fixed interest rate and repayment schedule when borrowing the money. Interest rates tend to be lower compared to revolving credit. This is largely because lenders take on less risk because the loan is tied to collateral that they can seize if you fail to make 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 determine what you are looking for financing for. Do you need a large sum of money for a single purchase or are you looking to do without your debit card for your daily purchases? You don’t want to take out a personal loan for your grocery expenses every 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 meet your credit terms.
Non-revolving credit tends to be used for one purpose, such as a car loan or student loan, and often comes with lower interest rates and regular repayment schedules.
For both types of credit, you must apply to receive a line of credit. However, a revolving line of credit only requires one application. If you wish to open another non-revolving line of credit, after paying off the balance of an existing line, you must submit another application. And there is no guarantee that the same terms or interest rates will be offered to you.
You can get more buying power with non-revolving credit because consumers can get approved for higher amounts based on your credit score and other factors. Can you pay for your new house or your new car with a credit card? Technically, yes. But that’s probably a bad idea. This is where non-revolving credit comes in.
Credit card issuers and banks take risk into account when extending revolving lines of credit to consumers. For this reason, banks tend to limit the amount of credit you can borrow. Generally, 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 determine what type of credit you might need in different financial situations.
Revolving credit products, such as today’s best credit cards, can be helpful when 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 repay. Be sure to choose the option that’s right for you, carefully considering what you need or want from a new line of credit.