Understanding Revolving Credit: Advantages and Potential Hazards
We all rely on different forms of credit to manage our financial lives. One such form is revolving credit, which can be a useful tool when used wisely. However, it also carries certain risks. This article will delve deep into what revolving credit is, its benefits and potential risks, and how to utilize it effectively.
What Exactly is Revolving Credit?
Revolving credit, as the name suggests, is a type of credit that rotates or continues to be available for your use. Think of it as a financial cycle – you borrow, repay, and then borrow again. The unique thing about this form of credit is that it doesn’t become debt until you actually use it, and as long as you don’t exceed the credit limit set by your lender, you can continue to use it indefinitely.
In simple terms, revolving credit is like a financial reservoir that you can dip into whenever you need, and then refill by repaying the borrowed amount. The most common examples of revolving credit are credit cards and lines of credit.
Different Forms of Credit
Revolving credit can come in various forms, each with its own characteristics and usage. Three of the most common types are:
Credit Cards
Credit cards are perhaps the most popular form of revolving credit. They come in two forms – secured and unsecured.
Secured Credit Cards
Secured credit cards require an upfront deposit, which then becomes your credit limit. These are often used by those with low credit scores, as they help build a positive payment history. The deposit acts as collateral for the lender, providing them with a safety net in case of default.
Unsecured Credit Cards
Unsecured credit cards, on the other hand, don’t require a deposit and have limits that can vary greatly. Your credit health determines the limit set by the bank. These cards might also come with annual fees and rewards such as air miles or cash back.
Unsecured Lines of Credit
An unsecured, or personal, line of credit is another type of revolving credit. Here, the bank approves your credit limit based on your creditworthiness. Unlike credit cards, interest charges on these lines of credit start immediately once you borrow and continue until you pay back the balance in full.
Secured Lines of Credit
Secured lines of credit, like a home equity line of credit (HELOC), are attached to an asset. In the case of a HELOC, you can borrow up to 80% of your home’s value. However, the risk here is that if you fail to repay, you could lose your home.
How Much Revolving Credit Should One Have?
A common question people often ask is how much revolving credit they should have access to. The answer to this largely depends on your financial situation and ability to repay.
As a rule of thumb, your available credit should not exceed the amount you can comfortably repay in full. It’s also important to keep an eye on your credit utilization ratio, which is the percentage of total credit you use from your total available credit. Aim to use no more than 30% of your total available credit each month.
Advantages and Drawbacks of Revolving Credit
Like any financial tool, revolving credit comes with its own set of pros and cons.
Advantages
- Accessibility: One of the main benefits of revolving credit is its accessibility. It’s a readily available source of funds that you can tap into whenever you need.
- Flexibility: With revolving credit, you have the flexibility to borrow as much or as little as you need, within your credit limit.
- Credit Building: Regular and responsible usage of revolving credit can help you build and maintain a good credit history.
Drawbacks
- Debt Accumulation: The biggest risk associated with revolving credit is the potential to accumulate more debt than you can handle. This can lead to a vicious cycle of borrowing and repaying, which can negatively impact your financial health.
- Interest Charges: If you don’t pay your balance in full by the due date, you will incur interest charges. Over time, these charges can add up and increase your overall debt burden.
Summary
In conclusion, revolving credit is a powerful financial tool that can provide flexibility and convenience. However, it also carries potential risks, such as debt accumulation and high-interest charges. Therefore, it’s crucial to use revolving credit wisely and responsibly. If you’re struggling with managing your revolving credit, don’t hesitate to seek professional help.
