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revolving credit
1 Jun 2019

Revolving Credit: What is it and How Does it Work?

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In 2017 Forbes magazine reported that by 2027 more than half of the United States workers will be freelancing.

This means more than half the US workers will also have an insecure income.

No one likes to feel like the bottom will fall out any day.

Great credit programs and opportunities can solve some of the problems of our financially insecure world. When the commissions are high you’re fine. But when the commission dips, how do you pay your mortgage?

Some of the best credit cards available today can help you with basic bills, but a different kind of credit exists other than what Mastercard and American Express can give you.

Enter revolving credit.

Read on for a full understanding of revolving credit–what it is, what it isn’t, what the positives and negatives are, and what you need to know to qualify for it.

What Is It?

Not all credit is the same. And this makes sense because not all needs for credit are the same. There’s a difference between paying for a washing machine and paying for a house.

Closed-end credit

Closed-end credit is the traditional personal loan. This means you ask for a specific amount of money, and you receive that specific amount of money.

The lending institution sets you up on a payment schedule in the form of an installment loans, and you have to send a check in every month for that specific amount.

When you apply for the loan, the institution sets your interest rate and does not change it. Typically, closed-end credit has a lower interest rate than open-end credit

You have an end in mind for your last payment. In fact, once you’ve sent that last check, the account closes.

And that’s typical, closed-end credit, but you probably knew this because that’s a common loan.

Open-end Credit

Closed-end credit is great when you know how much you need and where the money will go. But what happens when your need changes on a routine basis?

Take a home-improvement project for an example. The typical home-improvement project often goes over budget and takes place over a long timeframe. So a closed-end loan where you get a lump of money upfront just won’t work unless you want a half-done project.

Enter the open-end credit or the revolving loan.

Revolving credit does not have an end date (unless you do something silly like not pay your minimum payment).

Much like a wheel revolves with no end, a revolving online loan or revolving credit has no end until you, the borrower, make that decision.

Additionally, while revolving credit has a credit limit, it allows you to take out however much you need within that limit.

Every month you receive a statement that tells you your balance and available credit. At this point, you have a choice to pay off the balance (if you can) or to pay the minimum requirement.

The remaining balance is subject to a specific interest rate, which can change at the lender’s discretion.

And unlike closed-end credit, the revolving credit account stays open even when you’ve paid off the balance. You have it at your behest when you need it until you choose to close the account.

Let’s review:

Closed-end Credit:

  • fixed interest rate
  • set loan amount
  • monthly payment plan
  • lower interest rate

Open-end Credit:

  • variable interest rate
  • credit limit available daily
  • monthly minimum payment
  • higher interest rate

Types of Revolving Credit

You may be thinking, “Isn’t this just another name for a credit card?” And you’d be right, sort of.

A credit card is one type of revolving credit. Credit cards for bad credit have variable interest rates and a cap on how much you can spend. You have the option of paying the card off each month, and if you do, the account doesn’t close.

Furthermore, you can use the credit card for anything. With the right circumstances, some people have even purchased a vehicle with a credit card.

But revolving credit means more than just credit cards.

A revolving credit account at the bank means you have an open line of credit at the bank. All of the same standards apply to an open line that you see in a credit card with one difference: you’re working with a specific bank and specific people instead of a large institution.

Additionally, a revolving personal loan guaranteed approval from a bank has a lower interest rate than a typical credit card.

In addition to credit cards and lines of credit, a home equity line of credit qualifies as revolving credit. A revolving loan focused on home equity typically means you’re using your home as collateral.

How do you do this?

The value of your home and the amount in your outstanding mortgage determine your line of credit for a home equity revolving loan. Take how much you owe on your home, and subtract this amount from the value of your home. This is your limit.

Homeowners typically use a home equity revolving loan to complete a home improvement project, but you really can do anything with this line of credit:

  • pay off an existing credit card debt
  • go on vacation
  • complete a home improvement project

What is the Benefit of Revolving Credit?

So, if revolving credit accounts have costly variable interest rates that are typically higher than the average closed-end personal loan no credit check, why would you consider a revolving credit account?

Revolving loans work well under the right circumstances.

When You Need Money Immediately

Sometimes you just need money right away. Your car breaks down, your washing machine quits, your dog needs emergency surgery–these are things you do not plan for. Furthermore, you do not want to wait for the paperwork of a typical bad credit loan just to buy a new transmission.

Enter revolving loans. If you have a line of credit at the bank, you have the money that you need immediately without waiting for tedious paperwork, committees, and the red tape of approval.

When You Need Money for Anything

Murphy’s Law really does exist. When something bad could happen, it happens.

A revolving loan means you do not have to justify how you’re using your money, so you can handle unplanned expenses quickly and discreetly.

So whether you need money for something as necessary as a new furnace or as luxurious as a deal on a cruise, you have the cash you want.

And, as mentioned before, you have the freedom to use the money in a variety of ways. Vacations, credit card payments, automobile purchase, or a new deck–these would all qualify under a revolving loan because the loan will cover anything.

When You Have Fluctuating Income

While you may work a 9-5 job, 40 hours a week, you do not always have a 40-hour week paycheck.  If you’re working on commission or have a freelance job that pays by the job, you can have lean weeks.

Enter the revolving loan.

A revolving loan can help you pay the bills on the weeks that commission checks are low or work is scarce. Then, when the commission checks rise or work has picked up, then you can start paying back the line of credit.

You have to remember, also, the revolving loan or line of credit can be used again and again–it has no end, at least until you decide to close it.

When you want to improve your credit score

A revolving loan can improve your credit score if you manage it well. If you meet your payments and do not overreach with your limit, you will see your score improve.

What’s the Harm of Revolving Credit?

The negative side of revolving credit is also the positive side. Consider this:

You Have Money Available Immediately

You see something, and you have to have it. You know you only have to call the bank, and the banker will move the money into your account because you have this awesome line of credit.

Can you see the danger in this?

Revolving credit means immediate cash at your fingertips, even though it’s technically not your cash. This is even faster than if you were applying for a payday loan online, as the loan is already approved and ready for you.

When you have cash at your behest whenever you need it, you’re more likely to spend money you do not have. And even scarier, you’re may spend money that you will never have.

You Have Money for Anything

And again, the same scenario happens. You’re window shopping for hiking equipment, and you see a GPS unit you have to have.

You do not need to justify this buy now pay later purchase to anyone because you have a revolving loan you just paid off. Basically, the world (within your loan’s limits) is your oyster.

And why is this bad? Again, if you do not have the potential income to pay back your loan, you are looking forward months of financial stress.

Your Income Fluctuates

You have a great job, and you love what you do. You receive outstanding incentives when you do your work well.

But some months do not go like all months. If you have two or three months in a row with low sales and low commissions, you may not be able to make even the minimum payment on your revolving loan.

And as your income fluctuates, so can your interest rate. While credit cards typically have a higher interest rate than revolving loans in general, revolving loans still have a higher interest rate that can change randomly than a closed-end loan.

There Is a Solution

Revolving credit does not have to be a bad thing.

Despite the fact that credit card default rates have dropped since the Great Recession, 48 percent of Americans pay only the minimum balance on their credits cards.

So check yourself. Are you among the 48 percent? Or do you have the discipline to spend only on what you need and not what you want?

A well-disciplined borrower will have no problem with a revolving loan.

Another Type of Revolving Loan

When you think of revolving loans, you typically think of basic purchases or emergency expenses. After all, people don’t buy a house with a credit card.

Or do they?

Meet the revolving credit mortgage, also known as a revolving mortgage or current account mortgage. Basically, instead of a traditional mortgage where a bank issues a loan for the amount of the house, a revolving mortgage is a credit account where you can use up to a specific amount on your home and then whatever else you need or want.

Let’s say you get a $100,000 revolving mortgage. You have up to $100,000 to purchase a house. You can pay the money back to the bank as you can pay it with a monthly minimum requirement.

Thus on months when you earn some fat commissions, you pay a bunch back. When you have a leaner month, you pay the minimum balance.

Ironically, just because the revolving mortgage loan has the word mortgage in it, you do not have to use this account just for the mortgage.

Go back to that $100,000 revolving mortgage talked about earlier. If you wait a year and have a $95,000 balance, you can use the remaining $5,000 on a home improvement project.

So you’re using your mortgage money to improve the quality and value of your home.

This whole idea may seem a little risky. Why would you do this? After all, the interest rate can change per the bank’s discretion.

Again, fluctuating income. Because more people are working as independent contractors on commission, their incomes change monthly and sometimes even weekly.

Because you’re basically working with a bank account, you can opt to have your paychecks deposited into the mortgage account. This way if you have a big paycheck one month, you can simply withdraw what you need to live and you’ll have more going toward your mortgage.

Do I Qualify?

Like most loan programs, a revolving loan considers a variety of factors when you apply for a loan. In particular, the organization may look at your credit score, income, and job stability.

If you’re a business applying for a revolving loan, the institution will ask for documents such as the company income statement, statement of cash flows, and balance sheet.

After all, the revolving loan is a risk on both ends. No bank wants to lose money, so they will examine you as much as you’re vetting them.

In a nutshell, a bank wants to know you’re good for paying back what they loan you. Do you have the ability and the record that indicates you’re a good risk?

Revolving Credit in a Nutshell

Revolving credit is a risk, but it’s a necessary one in our world of fluctuating incomes. If you lose your job, you have a backup plan.

If you need money right now for something no one else would lend you money for, you have money.

Sure, there are the traditional methods of saving money for what may happen, but life happens even while you save.

And yes, borrowing money can be scary. Little time can pass before you find yourself neck deep in unmanageable debt.

But when you have discipline along with the right guidance, you can navigate murky financial waters where revolving credit lies along with a variety of other financial decisions.

If you’re not sure if you’re a good candidate for a revolving loan, check out our the resources available on our website. We can help you determine what course of action will best help you with your problem.

We would love to tell you more about us and our philosophies on our blog. Here are some other articles you might find helpful:

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