What it is:
Revolving credit is a line of credit individuals and corporations can borrow from and pay back as needed.
How it works (Example):
Revolving credit is also referred to as a line of credit (LOC)
Before granting a revolving line of credit to an applicant, a financial institution considers several factors that determine a borrower's ability to repay. For an individual applicant, credit score, income and job stability are the main factors considered. For a business, a financial institution may look at the company income statement, statement of cash flows and balance sheet to determine the business' ability to pay.
After a financial institution has approved an applicant's request for a revolving line of credit, the institution will decide on the maximum amount of credit it's willing to extend to that person or business based on their or its ability to pay; this maximum amount is known as the credit limit.
Revolving credit differs from an installment loan, which has a fixed number of payments to be paid over a definitive period of time. With a revolving line of credit, funds are borrowed as needed rather than all at once. Revolving credit borrowers are only required to pay interest on the amount borrowed, plus applicable fees (if any).
The most common examples of revolving credit offered by banks are home equity lines of credit, personal lines of credit and credit cards.
Why it Matters:
Similar to a credit card, revolving credit is useful for individuals and businesses that need to borrow funds quickly and as needed. A person or business that experiences sharp fluctuations in cash income may find a revolving line of credit a convenient way to pay for daily or unexpected expenses. Revolving credit applicants will generally be granted a line of credit if they have regular income, stability or cash reserves and a good credit score.
Revolving credit generally comes with higher interest rates than traditional installment loans, and the rate is variable rather than fixed. This means when interest rates are raised (or lowered) by the Federal Reserve, the rates on a revolving line of credit may go up as well. Set-up fees and other fees charged by an issuing bank may also be involved with taking out a revolving line of credit.