Like HowStuffWorks on Facebook!

How Revolving Credit Works


Advantages and Disadvantages of Revolving Credit
Blown away by your monthly credit card bill? Revolving credit accounts can gather a lot of interest from one month to the next.
Blown away by your monthly credit card bill? Revolving credit accounts can gather a lot of interest from one month to the next.
©istockphoto/alexsl

The greatest advantage of revolving credit is that it's available when you need it. You don't need to apply for a loan every time you don't have enough cash to buy something. You can also use as much or as little credit from your line of credit as you want. With a credit card, you can buy a pack of gum as easily as you can purchase a pair of Jet Skis.

Revolving credit can also be used for any type of purchase. Mortgages, for example, are only good for buying a home, and car loans can only be applied to automobiles. But even though a home equity line of credit is based on the equity in your home, it can be used for virtually any purchase. Most people use home equity lines of credit to finance home improvement projects, but you could also use the cash as a low-interest loan to fund your next vacation or to pay off higher-interest debt from a credit card.

­Revolving credit offers one financial solution to people who have steady jobs but irregular paychecks. Perhaps you're a successful car salesman, but some months are slower than others. With revolving credit, you can buy things on credit now and pay for them when you have the money on hand after a few big sales.

One of the greatest advantages of credit cards -- the most popular form of revolving credit -- is that they're safer to carry around than cash and they're accepted just about everywhere. Imagine if you had to keep enough cash on hand to pay for gas, groceries, movie tickets, parking and all your other incidental purchases.

But the convenience of revolving credit doesn't always outweigh its disadvantages. The greatest disadvantage of revolving credit is the temptation to spend money you don't have. For some consumers, a $10,000 credit limit is simply too hard to resist. They buy now without any thought as to how they'll pay later. And when they max out one credit card, they simply apply for another and start all over again. One in 10 Americans has more than 10 credit card accounts [source: CreditCard.com].

Sometimes revolving credit can be a little too flexible. Without fixed payments, many people wait too long to pay off their balances. Compound interest adds up fast, especially with revolving balances totaling thousands of dollars.

­Another danger of revolving credit (and this applies mostly to credit cards) is that the terms of the loan aren't fixed. If you read the fine print of your credit card agreement, you'll see that the lender can change your credit limit and interest rate any time. The lender is bound only to notify you in writing of the change. Your credit score may affect your credit limit and interest rate. If your credit score changes due to defaulted payments to other lenders, you become a risky borrower. Your interest usually changes to correspond to your risk level, that is, when and how quickly you can be counted on to pay the lender back.

If you understand the risks and benefits of your revolving credit account, you can certainly use it to your advantage. For more information on credit, debt and related topics, follow the links on the next page.

Finance Planning Tips

Here are some tips to help you with generating income and planning for the future.

Presented by United Way of Greater Atlanta Powered by SunTrust Foundation