If you’ve ever ordered a drink at a bar and coolly said, “Put it on my tab,” then you already know how a revolving line of credit works.
Revolving credit allows you to make a purchase with someone else’s money — in this case, the bar’s — and eventually repay it with your own. Once you pay up, your line of credit returns.
In the real world, a revolving line of credit could become an attractive and useful option for life’s more serious expenses. Let’s zero in on its definition and discuss the pros and cons.
What’s a revolving line of credit?
A line of credit gives you access to a set amount of money over an open-ended period. You only become responsible for interest once you decide to borrow from that amount.
Unlike other credit lines, a revolving line of credit revolves — or refills — when it’s repaid. That’s also how credit cards work.
Say your credit card limit is $5,000. If you make and pay off a $1,000 purchase, your card limit (or revolving line of credit) would increase from $4,000 to $5,000.
Companies often opt for revolving lines of credit to account for ongoing business expenses. Like business lines, personal lines of credit can be found via lenders such as banks and credit unions. You could use the funds for anything, even connecting it to your checking account for overdraft protection.
Like installment credit or loans, lines of credit can also be secured or unsecured. A secured line of credit, for example, would require you to put up collateral.
If you have a savings account, for example, you could use the money in it to get a lower interest rate on your revolving credit line at the same bank. On the downside, the savings account could be seized if you fail to repay your line of credit.
Unsecured lines of credit are more common and don’t require you to expose collateral. Your quoted interest rate on the credit line would likely be higher unless you have an excellent credit score.
6 pros and cons of revolving credit
Like all financial products, a personal line of credit isn’t the right choice for every borrower.
Take a moment to review its pros and cons to help determine whether you’re better off considering personal loan options.
1. Pro: You can borrow for ongoing expenses
Many installment loans require you to borrow a specific amount. A line of credit, on the other hand, could be used partially or completely.
Maybe you opt for a $15,000 line of credit over a home improvement loan because your project includes ongoing, unpredictable costs. If you could end up only borrowing (and having to repay) $10,000, you wouldn’t be responsible for repaying interest on the unused $5,000.
There’s another plus. Say you use all $15,000 of your line of credit and repay it. It’ll revolve back to $15,000 without you having to apply for a new line of credit or loan amount.
2. Pro: You can use a line of credit for just about anything
Installment loans also often have express purposes. Private student loans, for example, are typically disbursed directly to schools and applied toward eligible academic expenses.
With a line of credit, however, you might decide to use some or all of your line of credit on different types of expenses.
A home equity line of credit (HELOC), for example, is often used for home improvement, but it could also be used for a vacation.
Remember, however, that just because a line of credit could be used for an expense doesn’t mean it’s a wise choice. You wouldn’t want to pay for a trip to Hawaii with a HELOC because it’s a secured line of credit. You’re required to put your home up as collateral, meaning that it could be seized if your repayment goes south.
Even with an unsecured line of credit, it wouldn’t be smart to use funds for frivolous spending because you’ll be responsible for accruing interest on those purchases.
3. Con: Watch out for higher interest rates
Although you only have to pay interest on what you borrow from your line of credit, interest rates on lines of credit can be higher than those of personal loans from top lenders.
At Wells Fargo, for example, borrowers in California with excellent credit scores (760 or above) were quoted rate ranges of 10.50% to 15.00% for a $20,000 line of credit as of May 1, 2018. California borrowers with the same great credit, meanwhile, were quoted rates between 7.23% and 11.50% for $20,000 personal loans. Make sure to check with Wells Fargo for the most up-to-date rates.
4. Con: You might encounter variable interest rates
Interest rates on lines of credit, like credit card APRs, are variable, meaning that they could increase over time. There are also adjustable-rate lines of credit, which allow the lender to adjust the interest rate on your current balance or future charges.
If you decide to open a line of credit, ensure you sign on with a lender that explains why rates could rise and by how much. If a lender says your interest rate could rise to 20.00%, for example, run through scenarios to ensure you could afford repayment.
Say you spend all $10,000 of your credit line and need to repay it at that higher 20.00% rate. You’d be responsible for $2,000 in interest on your next payment. Otherwise, interest would begin to accrue and capitalize, as it does with other types of credit.
5. Pro: You can score lower rates if you’re creditworthy
Like with personal loans, lines of credit are lent based on your credit profile. The better your credit score, the better the rate you can receive.
Here is how Wells Fargo calculates rates on $20,000 lines of credit for borrowers of varying credit scores:
- Excellent (score of 760 or above): 10.50% to 15.00%
- Good (700 to 759): 10.50% to 18.25%
- Fair (621 to 699): 18.25% to 21.25%
- Poor (620 and below): 20.00% to 21.25%
The difference in rates could be meaningful. Repaying $20,000 at 15.00% would cost you $3,000 in interest if you repaid it in one lump sum. But repaying $20,000 at 20.00% would come with a $4,000 interest charge.
6. Con: Repayment is less straightforward and could be stretched
Like credit card accounts, lines of credit are open-ended. You don’t repay what you borrow over a set period.
That might sound preferable, but without an established monthly payment and a final payment deadline, you might be more likely to let your debt grow.
If you elect to open a line of revolving credit, ensure you have a plan to repay it. Use a payoff calculator to set a debt-free deadline. Otherwise, capitalizing interest could balloon your balance.
Is a revolving line of credit right for you?
If your income varies month to month, or if you have unpredictable expenses, a revolving line of credit could be the right way to fill in the gaps of your finances. You could borrow what you need and repay it at an interest rate befitting your credit score.
Although your credit score could lower your introductory interest rate on a line of credit, it could also take a hit if you tap into most or all of your credit limit. After all, “amounts owed” account for 30% of your score, according to FICO.
Borrowing a high percentage of your credit line — or having a high credit utilization ratio — could negatively impact your credit score. But using a smaller percentage of your line of credit could increase your score too.
Still, revolving credit isn’t the right choice for everyone, especially if you could score a lower interest rate on another product. Compare lines of credit and personal loans to decide which is best for you.
Note: Student Loan Hero has independently collected the above information related to Wells Fargo personal loans and lines of credit. Wells Fargo has neither provided nor reviewed the information shared in this article.
Interested in a personal loan?Here are the top personal loan lenders of 2018!
|Lender||APR Range||Loan Amount|
|1 Includes AutoPay discount. Important Disclosures for SoFi.
2 Includes AutoPay discount. Important Disclosures for Payoff.
3 Important Disclosures for FreedomPlus.
4 Important Disclosures for Citizens Bank.
Citizens Bank Disclosures
5 Important Disclosures for LendingPoint.
6 Important Disclosures for LendingClub.
All loans made by WebBank, Member FDIC. Your actual rate depends upon credit score, loan amount, loan term, and credit usage & history. The APR ranges from 6.16% to 35.89%. For example, you could receive a loan of $6,000 with an interest rate of 7.99% and a 5.00% origination fee of $300 for an APR of 11.51%. In this example, you will receive $5,700 and will make 36 monthly payments of $187.99. The total amount repayable will be $6,767.64. Your APR will be determined based on your credit at time of application. The origination fee ranges from 1% to 6% and the average origination fee is 5.49% as of Q1 2017. There is no down payment and there is never a prepayment penalty. Closing of your loan is contingent upon your agreement of all the required agreements and disclosures on the www.lendingclub.com website. All loans via LendingClub have a minimum repayment term of 36 months or longer.
7 Important Disclosures for Earnest.
8 Important Disclosures for Avant.
* The actual rate and loan amount that a customer qualifies for may vary based on credit determination and other factors. Funds are generally deposited via ACH for delivery next business day if approved by 4:30pm CT Monday-Friday. Avant branded credit products are issued by WebBank, member FDIC.
** Example: A $5,700 loan with an administration fee of 4.75% and an amount financed of $5,429.25, repayable in 36 monthly installments, would have an APR of 29.95% and monthly payments of $230.33
* Important Disclosures for Upgrade Bank.
Upgrade Bank Disclosures
** Accept your loan offer and your funds will be sent to your bank via ACH within one (1) business day of clearing necessary verifications. Availability of the funds is dependent on how quickly your bank processes this transaction. From the time of approval, funds should be available within four (4) business days.
|7.73% – 29.99%||$1,000 - $50,000||Visit Upstart|
|6.26% – 14.87%1||$5,000 - $100,000||Visit SoFi|
|6.99% – 35.97%*||$1,000 - $50,000||Visit Upgrade|
|8.00% – 25.00%2||$5,000 - $35,000||Visit Payoff|
|4.99% – 29.99%3||$10,000 - $35,000||Visit FreedomPlus|
|5.99% – 18.99%4||$5,000 - $50,000||Visit Citizens|
|15.49% – 34.49%5||$2,000 - $25,000||Visit LendingPoint|
|6.16% – 35.89%6||$1,000 - $40,000||Visit LendingClub|
|6.99% – 18.24%7||$5,000 - $75,000||Visit Earnest|
|9.95% – 35.99%8||$2,000 - $35,000||Visit Avant|