Revolving Credit vs. Non-Revolving Credit: What are the Pros and Cons of Each?
Personal finance is full of technical terms that can easily throw the average consumer off. Instead of letting the credit card companies win, you can learn about revolving credit and how it works. By understanding how the game is played, you can ensure that you’re in good financial health with a good credit score.
What is Revolving Credit?
Revolving credit is another way to reference any line of credit that renews on a set cycle. Usually these cycles are a month long, making the most well-known form of revolving credit your credit card.
Revolving credit is important because of the flexibility it gives you. If you are a given a line of credit up to a certain amount for a given month, then you can use any portion of that credit line that you desire. Once the month is over, you pay your balance in full or meet a minimum required payment determined by your lender. After that, the next cycle begins and your line of credit is renewed, either in full or minus your outstanding balance at the end of your last cycle. Regardless of how big your credit limit is, the balance you owe is only the amount you spent.
Using a credit card as an example, we can see how revolving credit works. You open an account with your credit card company and they give you a line of credit. Let’s say that they give you $1,000. You can spend any amount of that credit limit that you desire, so let’s say that you spend $200. You’re financially savvy and you want to avoid credit card debt, so you pay your balance in full at the end of the month. When the next month comes, you’ve got the whole $1,000 again to spend (or not spend) as you wish. If you play your cards right and keep up good credit card habits on this account, then you will probably be in a position to negotiate for a higher credit limit in the future.
What is Non-Revolving Credit?
This is all fairly simple, but it really comes together when you understand non-revolving credit too. Non-revolving credit is a term for any form of credit that is not renewed on a set cycle. In other words, non-revolving credit is any type of one-time loan that you receive. This can anything from a personal loan, to a mortgage, and even student loans.
What’s important to remember about non-revolving credit is that you have a lot less flexibility with the loans that you receive. If you take out a $10,000 loan to buy a new car, then you are responsible for all $10,000. Additionally, you cannot count on getting another $10,000 the next time that you need a new car. Non-revolving credit is a one-time arrangement between a lender and a borrower, so you have to make the most of it.
Non-revolving credit is often best for large purchases. This is because, unlike revolving credit, non-revolving lenders don’t have to worry about meeting their lending obligations month over month. Instead, they just need to lend you one large sum of money at a single point in time. Non-revolving credit can also carry lower interest rates than revolving credit, although that isn’t an absolute rule. While mortgages have been known to carry APRs in the single-digits and credit cards often charge 15, 20 or even 30 percent interest, payday loans and other predatory products
When to Use Revolving Credit
Revolving credit is a great way to improve your credit score. Thanks to its consistent nature, revolving credit gives you the opportunity to show month over month that you are capable of handling debt responsibly and making payments on time.
Unlike non-revolving credit, revolving credit accounts can be left open when they aren’t seeing use. Although it may be tempting to close accounts that you’re not using in order to avoid things like annual fees, this is actually a major mistake that many cardholders make. Instead of closing accounts unnecessarily, try hanging on to older credit card accounts, even when they are not in use. Having an older credit card account will help to establish a strong credit history for you. Ultimately, having a good and extensive credit history will help you when it comes to negotiating with your credit card company. It can also help when you need to use non-revolving credit, like getting a mortgage for a new home.
Understanding how revolving credit works is important to making sure that you are in the best financial health possible. Save non-revolving credit for big purchases when you only need a one-time lump sum, but use revolving credit for smaller items in order to establish a good credit history and improve your credit score.
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Nick Cesare is a writer from Boise, ID. In his free time he enjoys rock climbing and making avocado toast.
This post was updated September 29, 2017. It was originally published October 3, 2017.