Revolving Credit for Daily Expenses and Major Purchases

Revolving credit is an agreement between a company or an individual borrower and a financial institution, which offers funds on demand. Borrowers can draw on the line whenever they need funds but are under no obligation to use the money. There are different types of revolving debt such as credit cards, lines, and home equity lines.

How Revolving Credit Works

Financial institutions have different lending criteria but usually take into account the applicant’s payment history and score. Other factors include employment history, income level, debt utilization rate, debt-to-income ratio, and more. Lenders look at these factors to assess the applicant and offer terms of repayment, limit, and interest rate. Once approved, borrowers can draw on the line up to the available limit. They can pay the balance in full during the interest-free period, and interest charges are not assessed. Another option is to pay the minimum and then repay the outstanding balance over a certain period. Interest charges apply in this case, and borrowers pay at an interest rate of 5 to 28 percent. Carrying a balance month after month, especially if the card comes with a high interest rate, can cause serious financial problems.

Personal and Business Credit Cards

Finance companies, banks, caisses populaires, online companies, and other entities offer different types of personal and business cards. The main types of cards, offered by banks, are Discover, American Express, MasterCard, and Visa. However, each lender has different criteria for approval. As a rule, borrowers with poor credit have access to cards with participation, membership, and annual fees. They can opt for prepaid, secured, or department store cards. Applicants with a good payment history can choose from rewards, airline, low interest, and other types of cards. Financial institutions look at the borrower’s annual income, and many lenders have minimum income requirements. Applicants should be of legal age and residents or citizens of the country in which they apply for the card. Financial institutions do not take into account the borrower’s age, religious affiliation, ethnicity, or gender. When applying for a credit card, borrowers should fill in information such as social security number, address and telephone, employer, length of employment, and other details.

Lines of Credit for Companies and Individual Borrowers

This is another form of revolving debt that allows borrowers to use funds up to the available limit. They can draw on the line multiple times and whenever they need it. The main advantage for borrowers is that they pay interest only on the money used. There are different types of LOCs – secured, unsecured, business, and personal. Customers usually apply for a secured LOC to finance major purchases and home renovation projects. Financial institutions require that borrowers offer collateral in the form of home equity, cash, bonds, stocks, or other assets. Banks offer secured LOCs with a credit limit of up to $200,000. Customers can access their line of credit through online, telephone, and mobile banking, as well as through ATMs and local branches. Borrowers benefit from detailed monthly statements and personalized checks. There are differences between secured and unsecured lines, and one is that the latter go with a higher interest rate and a lower limit. Borrowers who opt for a secured LOC enjoy a higher limit and can use the money to buy a second home, cottage, or investment property. The major advantage of an unsecured line is the faster approval process. This is a good option for borrowers who need quick cash. Moreover, customers take less risk given that collateral is not required.

HELOC, Pros and Cons

A home equity line of credit is another form of revolving debt, which is set for a maximum draw. Financial institutions promise to advance a certain amount of money, say $200,000, whenever the borrower needs it. He can draw on the line in different ways – through a special card, check, etc. The borrower’s home equity serves as collateral, and the bank can seize the property in case of default. Customers usually apply for a HELOC to finance large home renovation projects, major purchases, tuition and board, and other expenses.

In essence, a home equity line of credit is a second mortgage, which makes it a risky borrowing instrument. The main benefit is that lenders offer long draw periods of up to 10 years. Another benefit is that borrowers pay low upfront costs and can pay interest only on the amount used.

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