The Difference Between Revolving Credit vs Line of Credit
Revolving Credit vs. Line of Credit: An Overview
Revolving credit and a line of credit are financing arrangements made between a lending institution and a business or an individual. The lender provides access to funds that the borrower can use at his discretion; it's like a flexible, open-ended loan. In fact, a revolving credit line is a type of credit line. A line of credit is a one-time arrangement, and when the credit line is paid off, the account is closed.
There are two features of both kinds of lines of credit that make them particularly attractive: purchase flexibility and payment flexibility. Like a credit card, these can be used on an as-needed basis and paid off when it is convenient, depending on terms of the line of credit.
Revolving Credit
Revolving credit is very similar to a credit card; in fact, some institutions refer to a revolving credit agreement as a revolving line of credit. The lending institution grants you a maximum credit limit, which you can use to make purchases at any time and (usually) on any goods.
Many small business owners and corporations use revolving credit to finance capital expansion or as a safeguard in the event of cash flow problems. Individuals might use it for overdraft protection on demand deposit or checking accounts or to cover large, ongoing expenses, like house renovations or medical bills.
If you make regular, consistent payments on a revolving credit account, the lender may agree to increase your maximum credit limit – again, like a credit card. There is no set monthly payment with revolving credit accounts, but interest accrues and is capitalized like any other credit. When payments are made on the revolving credit account, those funds become available for borrowing again. The credit limit may be used repeatedly as long as you do not exceed the maximum.
A home equity line of credit also called a HELOC is an example of a revolving credit line. A pre-approved amount of credit is given based on the value of the borrower's home, making it a secure type of credit. The funds in the account can be accessed in various ways, via check, a credit card connected to the account, or transfer. You only pay interest on the money you use, and the account offers flexibility to draw on the line of credit when needed.
Line of Credit
Non-revolving lines of credit have the same features as revolving credit (or a revolving line of credit). A credit limit is established, funds can be used for a variety of purposes, interest is charged normally, and payments may be made at any time.
There is one major exception: The pool of available credit does not replenish after payments are made. Once you pay off the line of credit in full, the account is closed and cannot be used again.
An example: personal lines of credit are sometimes offered by banks in the form of an overdraft protection plan. A banking customer can sign up to have an overdraft plan linked to his or her checking account. If the customer goes over the amount available in checking, the overdraft keeps them from bouncing a check or having a purchase denied. Like any line of credit, an overdraft must be paid back, with interest.
Revolving Credit vs. Line of Credit - Special Considerations
Revolving lines of credit and a line of credit are both different from other traditional loans. Most installment loans, such as mortgages, auto loans or student loans, have specific purchasing purposes in mind. You must tell the lender what you are going to use the money for ahead of time and you may not deviate from that, unlike a line of credit or revolving credit.
Traditional loans also come with set monthly payments, while most lines of credit do not. The payments on lines of credit tend to be more irregular, because (unlike a loan) you are not being lent a lump sum of money and charged interest right away. A line of credit is more the ability to borrow funds in the future up to a certain amount; you are not charged interest until you actually start tapping into the line for funds.
Like loans, both revolving credit and non-revolving lines of credit come in secured and unsecured versions. A secured credit is borrowed against a tangible asset, like a house or car, which serves as collateral; as a result, interest rates on secured credit accounts tend to be much lower than those on unsecured credit accounts.
Unsecured lines of credit are usually not your best option if you need to borrow a lot of money. If you plan to make a one-time purchase, consider a personal loan instead of a line of credit. Loans tailored to a specific purchase, such as a home or a car, are often good alternatives to opening a line of credit.
Key Takeaways
- A revolving line of credit is a dynamic financial product, as you pay the credit down, you may be offered more credit to spend, especially if you make regular, consistent payments on a revolving credit account.
- A line of credit is a one-time financial arrangement or a static product. When you have spent the set amount of credit, the account is closed.
- Personal loans or loans tailored to a home or automobile may offer better rates, and more security for the borrower, than a line of credit.
- Both revolving credit and credit lines come in unsecured and secured versions.
- Revolving credit or a line of credit both have many of the same risks as credit cards.
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