What Is an Open-End Loan (Revolving Credit)?

FT Contributor  | 

An open-end loan, also sometimes referred to as open-end credit, is a form of borrowing that can be used up to a certain limit before it must be repaid. The borrower is able to withdraw indefinitely until the limit is met. Open-end loans are also sometimes referred to as revolving credit.

In contrast to more traditional loans, which are given upfront in a lump sum (often for a specific purpose, such as purchasing a car or real estate) and must be repaid in full along with any additional fees by a pre-established time, open-end loans represent loans with no fixed spending or even (in some cases) fixed repayment dates that can be kept open for an indefinite period of time.

Examples of an Open-End Loan

A common type of open-end loan is a line of credit. Open-end loans can also take the form of credit cards or home equity lines of credit. With open-end loans, borrowers can spend money up to a pre-approved limit, known as the revolving credit limit. If they carry over a balance on their credit card or loan from month to month, borrowers may have to pay interest and a minimum payment on the amount at a pre-established rate. If a borrower pays off some of the balance of their open-end loan, this amount immediately becomes available for them to spend again.

Line of Credit

A line of credit is a type of open-end loan that is usually backed by a financial institution. Lines of credit are often secured, which can mean that they have better interest rates than unsecured open-end loans like credit cards. Secured lines of credit are backed by assets like homes or vehicles, while unsecured lines of credit don’t require any collateral. While they offer better rates, secured lines of credit can sometimes be more difficult to obtain than unsecured lines of credit.

Credit Cards

Credit cards are one of the most common types of open-end loans and can be issued by businesses, banks, and other lenders. Credit cards can be used to finance purchases regardless of cash flow disruptions, and they can offer rewards programs and other perks. Credit card limits can often be increased or decreased depending on an individual borrower’s behavior and credit history.

Home Equity Lines of Credit

Home equity lines of credit (HELOC) allow homeowners to borrow against the equity that they have invested in their homes. Home equity lines of credit are secured by the value of the home, so they often offer very competitive interest rates. Home equity lines of credit are often used to finance expensive purchases, like additions and improvements to a house or a child’s college tuition. Because home equity lines of credit are tied to property, it’s important for borrowers to be especially responsible with this type of credit in order to avoid potentially putting their home at risk.

Open-End Credit vs. Closed-End Credit

With an open-end loan, a borrower qualifies for a maximum loan amount for a non-specific purpose without a fixed payment schedule. This means that a borrower has a certain amount of credit available to them but doesn’t necessarily have to spend it. The lender may lower or increase the open-end loan limit according to the borrower’s history with the individual lender as well as their overall credit history.

In contrast, closed-end credit is a loan where the borrower is provided with a specific loan amount for a specific purpose. There is a time limit within which a closed-end loan must be repaid. Payment terms for a closed-end loan involve fixed, equal monthly payments over a predetermined period of time. Common types of closed-end loans include loans taken out to finance the purchase of a home, automobile, or educational expenses.

The repayment terms of both open-end and closed-end loans vary depending on the borrower’s financial history and credit score. Those with high credit scores able to secure more favorable interest rates.

One potential benefit of these fixed payments is that they are predictable, allowing you to budget around them. The repayment terms for closed-end loans generally take the form of a fixed equal payment each month for the duration of the loan. With an open-end loan, the minimum necessary payment is based on the size of the revolving balance and accumulated interest.

Both open-end and closed-end loans can affect your credit score, but closed-end loans are generally less dangerous for your credit. Open-end loans have a higher impact on your credit score, particularly your credit utilization, which refers to the ratio of how much credit is available to you and how much you’re currently using. A high credit utilization ratio can make you seem like a risky borrower to potential lenders, while a large amount of closed-end loans does not necessarily pose the same financial risk. While repayment of both closed-end and open-end loans can be used to build credit, open-end loans generally have a greater impact.

For borrowers with good credit history, closed-end loans can have more favorable terms than open-end loans. Closed-end loans generally have lower interest rates than open-end loans, making them cheaper to pay off in the long term. Open-end loans usually have higher interest rates, and the interest compounds each month, resulting in an increased balance. Open-end loans also often involve fees for late payments or annual maintenance.

Benefits of an Open-End Loan

Open-end loans provide more flexibility than closed-end loans and can be beneficial to borrowers when used wisely. Open-end loans also don’t normally charge interest on any unused funds, which makes them an attractive alternative to closed-end loans for many borrowers. Many types of open-end loans can also be used indefinitely as long as a borrower hasn’t yet reached their credit limit. Open-end loans can be paid off at any time. In contrast to closed-end loans, which have fixed payment terms and a set time limit for the repayment plan, open-end loans can offer flexibility in spending.

Open-end loans like credit cards also often feature perks like cash back and travel rewards. Many borrowers use open-end loans to finance all of their purchases, paying the balance off at the end of each month, in order to make the most of these rewards. While high credit utilization does happen, it’s a good idea to keep your credit utilization low and to pay the balance off each month if possible. While open-end loans do come with risks, they can be an appropriate way to finance purchases regardless of cash flow as long as they are used responsibly.

Open-end loans do come with risks. If borrowers spend unwisely, they can be faced with a lot of debt and little ability to pay it off. Unpaid balances are also subject to interest that accumulates over time, so that even if they make minimum monthly payments, borrowers may not be making progress on paying down their debt. If the open-end loan is a secured line of credit backed by a fixed asset, such as a home or other property, borrowers run the risk of losing that property if they fail to make the required payments.

Open-end loans can be especially risky when individuals borrow more than they are able to realistically pay back. This can leave them with a large amount of revolving debt that carries over each month, accumulating interest and negatively impacting their credit score. Because open-end loans are flexible and can be used for a variety of different expenses, they can also sometimes encourage risky spending on items that aren’t necessary and that might not otherwise fit into your budget.

As long as borrowers use open-end loans responsibly, however, they can take advantage of the many benefits of a revolving line of credit. For the best results, it’s a good idea to pay off the balance of an open-end loan each month in order to avoid paying interest or other related fees. Even if you’re not able to pay the full amount, paying an amount that’s greater than the minimum required payment will help to decrease your balance more quickly. And as long as you maintain a low credit utilization ratio, open-end loans can have a positive impact on your credit score.


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This post was updated November 7, 2019. It was originally published November 7, 2019.