Revolving Credit vs. Line of Credit: Key Differences Explained

As a borrower, understanding the impact of credit and the types of credit available can help you intelligently leverage your wealth without risking high fees, interest and long-term debt. The two most common borrowing options are a revolving credit or a line of credit. A credit card is the most common form of revolving credit, while a home equity line of credit (HELOC) or a personal line of credit are common types of lines of credit. 

The solution to whether you should use credit for your financial health isn't to avoid it completely. Instead, understanding how revolving credit and a line of credit work and their importance in financial management can help you build greater financial opportunities. Read on to understand revolving credit versus line of credit and how you can use each. 

What is Revolving Credit?

Revolving credit allows you to borrow money as needed, repay with minimum payments and then borrow again. There is only a minimum set monthly payment with revolving credit accounts. However, you'll incur high interest rates on any charges you carry over to the next month. With revolving credit, you only owe interest on the amount spent and not repaid, not the entire credit line. The most common type of revolving credit is a credit card. 

After you open a revolving credit account, it will remain open until the lender or borrower closes it. Revolving credit is convenient. You can use it and repay it over and over. Your revolving credit use is reported to the three main credit bureaus and can help or harm your credit score. 

You'll get a credit limit when approved for a revolving line of credit. While you can make charges up to the credit limit and beyond it with some card issuers, using more than 30% of the available credit may cause a reduction in your credit score.  

If you pay the credit card on time each month and keep credit utilization below 30%, the overall effect of revolving credit should be positive for your credit score. Learn how to apply for a credit card here.

How Revolving Credit Works

Suppose you apply for a credit card. You're approved with a $5,000 credit limit. The card has a variable annual percentage rate (APR) that averages 28%. You charge $700 in groceries, gas and other household expenses in the first month. 

The minimum payment due is just $40, but if you pay that, you'll be charged interest on the remaining $660 at an average rate of 28% annually until it's paid off. In the first month, that means accumulating around $15.40 in interest. If, on the other hand, you pay off the credit card in full, you have the full $5,000 credit limit to use the next month without having to pay any interest or fees. 

An interesting feature of revolving credit is that if you make regular, consistent payments on the account, the lender may increase your maximum credit limit over time. You can even request a credit line increase every six months to one year. This is known as the accordion feature of revolving credit. 

Pros and Cons of Revolving Credit

Revolving credit has pros and cons, including:

Pros:

• Convenient way to pay
• Access an additional line of credit when you need it
• Many credit cards come with no annual fees, so you won't pay anything as long as you pay it off in full each month
• Build a good credit score with on-time payments and low credit utilization

Cons:

• Interest rates are high
• Late fees, annual fees and other fees can add up
• It's easy to spend more than you budgeted

What is a Line of Credit?

A line of credit is a type of financing in which the lender provides funds up to a certain credit limit that can be used and paid back at the borrower's discretion. In that way, a line of credit is similar to a credit card. With a line of credit, the lender usually specifies a draw period with an end date or terms for a period when you can make payments but can no longer make withdrawals. 

A personal line of credit and a home equity line of credit are examples of lines of credit. With either of these, you can use checks to withdraw funds from your line of credit. 

The advantage of a line of credit over a credit card is the possibility of a larger draw for major projects like home renovation. HELOCs also typically have lower interest rates than credit cards. This is helpful for home renovations and other big expenses where additional large expenses can cause you to draw more from the line of credit. 

A line of credit is usually nonrevolving, meaning it won't be replenished when you draw the available amount. In HELOCs, for example, there will be a draw period in which you can draw up to the full approved loan value. This is followed by a repayment period. 

A line of credit and revolving credit have different structures, including the draw and repayment period. Unlike revolving credit, where you'll pay high interest even in the first year, nonrevolving credit usually comes with a draw period between five and 15 years, with 10 years being average. The repayment period is usually between 10 and 20 years. 

How Line of Credit Works

A line of credit is a flexible loan you can secure from a bank, credit union or online lender. A line of credit may be secured or unsecured. A secured line of credit is backed by equity. In the case of a HELOC, for example, the line of credit is backed by the equity you've built up in your home. 

With a line of credit, you can repay the loan immediately or over time. There is usually a fixed interest rate, but some lines of credit come with variable interest rates. A fixed interest rate on a line of credit makes it easier to calculate the lifetime cost and plan for repayment as the rate doesn't change.

Suppose you're renovating your home, and you have $100,000 in equity built up in the home. The lender may approve you for a HELOC of up to $80,000. You can borrow up to that amount. When renovations begin, you estimate you'll only use $30,000. By the time renovations are finished, you've drawn $38,000 from the line of credit. Then, according to the HELOC terms, you have up to 15 years to repay the loan. You can also pay it off in less time if you prefer. 

Pros and Cons of Line of Credit

Pros:

• Convenient way to access funds
• Can be secured or unsecured
• Choose to use funds or not; only pay interest on funds used
• Can be used for anything, from home renovations to a wedding, college expenses or medical fees

Cons:

• Variable interest rates make it more difficult to budget
• Fees can add up
• If you've taken a HELOC, you'll risk losing the home if you fail to meet repayment deadlines
• Excessive borrowing can harm your financial health

Revolving Credit vs. Line of Credit: Similarities and Differences

Revolving credit vs line of credit have similarities as well as a few differences. First, both are debt products that give you access to funds. Both only require you to pay interest on the funds you use. Both offer the flexibility to spend as you need and state a maximum credit limit. 

The difference is that credit cards and other revolving credit come with high interest rates. If you don't pay off the credit card in full each month, you'll pay significantly in interest and possible fees. In contrast, lines of credit may have fixed or variable interest rates that are generally lower than revolving lines of credit. In addition, lines of credit often have a draw period followed by a repayment period. During the draw period, you'll only pay interest and won't be required to repay the funds borrowed.

Another difference is available funds. With a line of credit, once you've drawn funds, they don't renew. This contrasts with revolving credit, in which your available credit renews when you pay off the card. In addition, your credit limit with revolving credit may increase over time while a line of credit is set. 

In addition, how you might use revolving credit versus a line of credit varies. Revolving credit is usually used for regular monthly expenses or single large purchases you plan to pay off quickly, like a TV or computer. A line of credit is usually used for larger unpredictable expenses like a home renovation, a wedding, medical expenses or education. 

Lenders may look at different factors to approve revolving credit versus a line of credit. Most borrowers will be approved for revolving credit, even with a lower credit score, although they may get a lower credit limit. On the other hand, lenders may look at equity, income and total debt when approving a line of credit. 

Tips for Managing Revolving Credit and Line of Credit

The best practice for using and repaying revolving credit is to pay it off in full each month. For this, don't spend more than you earn and can comfortably pay back. If you accumulate debt on a credit card or other revolving credit, work to pay it off as quickly as possible. If you're already carrying debt, you can use the debt snowball or debt avalanche method to pay it off faster.

And to effectively manage a line of credit, remember that it's not free money. You'll end up paying more in interest on anything you borrow. For that reason, avoid spending more than you budgeted, and create a plan to pay it off on time or early. 

Choosing Revolving vs. Nonrevolving Credit Lines

Depending on your needs, there are times when leveraging your wealth with debt can be a smart financial move. For example, a home renovation that increases your home's value more than the cost of the renovation can be a smart move. Likewise, a revolving line of credit you pay off monthly, like a credit card, can offer attractive perks and a convenient payment solution. Using both revolving and nonrevolving credit lines responsibly can help you build a good credit score and greater financial opportunities. To get started, find different types of credit cards here.

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