Every once in a while, life throws you a financial curve ball. Unfortunately, these wayward cash calamities rarely strike the day after payday. In fact, they often occur when you can least afford the monetary hit. Enter revolving loans to save the day. While the term “revolving credit loan” may sound foreign and intimidating, chances are you’ve already heard of the most common types of revolving loans. Here’s what you need to know about revolving loans, how they work, and if they are the right choice for your financial situation and needs.
What is a Revolving Loan?
There are two common types of revolving loans available to consumers today. One is a personal line of credit, and the other is a credit card. Chances are you’ve heard of both and may even have considered these loan types as part of your overall financial plan.
The critical takeaway for revolving loans is that the balance remains available as you repay the loan. That is, minus the appropriate fees and interest charged against your account. Revolving lines of credit and loans may be secured or unsecured. More sizeable lines of credit are often secured by items of more significant value, such as the equity in your home in the case of a home equity line of credit. Credit cards may be secured by a particular bank account or unsecured according to your credit history.
How Revolving Loans Work
Revolving credit is different than your typical installment loan. Rather than receiving a lump sum loan upfront and repaying the borrowed amount, you receive a credit limit. This is a specific dollar amount available to you to borrow against. Consider it a “well” of money you can return to as needed until you’ve borrowed the maximum amount or credit limit.
The more times you visit the well to “borrow” funds, the fewer funds are available to you to borrow. When you make payments, whether paying the amount in whole or a portion of the amount you’ve borrowed, the well is refilled, and your available credit (or a portion thereof) is restored.
Benefits
There are always strengths and weaknesses to consider when borrowing money. These are a few benefits revolving loans offer over standard installment loans, and keep them in mind as you explore your options and work to make a well-informed decision.
- Revolving loans provide on-demand financial resources for life’s little emergencies.
- They offer repayment flexibility that is unavailable with installment loans.
- You can refill the well by making payments each month.
- They deliver the ability to eliminate interest by paying your balance in full every month.
The last benefit is significant for those with the financial discipline to pay off the balance monthly. This can be an excellent tool for disciplined spenders to help with life’s little emergencies and to plan for lean weeks in your monthly budget.
Drawbacks
Now it’s time to explore the potential drawbacks of revolving loans. Some of the pitfalls associated with revolving credit can be prohibitive, so consider them carefully before you take the plunge.
- Borrowing against your credit limit increases your credit utilization rate, which lowers your credit score (ideally, this number will be 28 percent or less).
- Payments vary according to the amount you’ve borrowed from your well (plus fees and interest).
- With credit cards, interest rates can be prohibitive. They are often driven by market conditions, the state of the economy, and your credit score. Annual rates above 20% are not unheard of.
- They require considerable self-control and discipline to resist the temptation to overspend.
- Secured revolving loans can place items of great value to you and your family at risk if you cannot repay the loan.
While some consumers can put these cards away and save them for emergencies, others struggle with the temptation to buy the “little extras” with fast access to additional funds. These small purchases add up fast. When you consider the higher interest rates and risks of losing valuable possessions.
Tips for Using Revolving Loans Responsibly
The key to using revolving loans responsibly is to dip into the “well” of money they offer as infrequently as possible. If you must borrow against these credit limits, pay the balance in full or as close to full as possible each month. This helps keep your credit utilization rate low and secures those funds, so they are there when true financial emergencies arise. The longer you have a balance against these funds, the more interest you pay.
Alternatives to Revolving Loans
Some people understand the inherent risks and temptations of revolving loans and opt to seek other loans instead. One such option is an installment loan. These loans allow borrowers to borrow a lump sum of cash and make a fixed over a specified number of weeks, months, or years.
Revolving loans can be highly beneficial in emergency situations. They help consumers stretch their money to the end of the month. However, they pose significant financial risks if you aren’t careful when using them. Exercise caution with revolving loans to maximize their benefit while minimizing your risks.