Instead of being given the principal of the loan up front, as with a mortgage or other installment type loan, a revolving loan provides the borrower with the ability to borrow up to a certain amount at any time with no prior notification.
Revolving loans have several important advantages over installment loans and are generally the better choice, although many borrowers are not aware of these advantages and, given the choice, they will often automatically choose an installment loan without really thinking much about it.
A good loan advisor should sufficiently explain the benefits of each in an effort to provide borrowers with the opportunity to make an informed choice, but retail loan advisors are generally not that well trained and they often function more as order takers than advisors.
Some of the basics though are often explained, such as the fact that revolving loans are based upon variable rates, where you can go either fixed or variable with an installment loan. So, if both types of loans make sense and you really prefer a fixed rate over a variable one, this will sway the decision toward getting an installment loan over a variable loan.
Risk Tolerance
While a borrower’s personal risk tolerance does matter, this is not just a matter of some borrowers being more risk averse than others, although risk appetite does factor into things. It’s also a matter of one’s particular situation being able to tolerate risk more or less, and there are a number of things that influence this.
Some people simply have a bigger risk appetite than others, from a psychological perspective, and it’s not really the goal of lenders to educate borrowers too much on this, although this is something they could focus on a little more than they do generally.
If a borrower is bothered psychologically with the possibility of rates going up too much, that in itself is going to be a material concern, provided that this feeling persists after the loan is negotiated. One’s satisfaction and happiness is the goal of all of this, increasing it, and if the terms of the loan negatively affect this, then this should matter, no matter how informed the decision is from an objective standpoint.
There are other things that can affect this decision, especially if one is close to one’s capacity to repay the amount sought, then that should influence the decision of whether to go with a fixed or variable rate, and therefore whether a revolving loan is going to be a comfortable option.
Lenders will generally account for this by having a little stricter requirements as far as what debt ratios they will approve for revolving loans, and will be a little more lenient with installment loans, although they don’t usually differentiate between fixed and variable installment loans as far as debt tolerance goes.
The reason why the standards are set a little tighter for revolving loans doesn’t have much to do with the fact that they are variable rate products, but this does serve to provide a little more buffer for those whose debt situation is or may be expected to be tighter.
The outlook for interest rates during the next few years doesn’t really come up that much in these discussions, even though we usually have a decent idea of where things may be headed. In times where more interest rate volatility to the upside may be expected, more caution is needed when taking on revolving debt, although this doesn’t necessarily mean one should shy away from revolving loans, because there’s much more to deciding this then whether one wants to go fixed or variable.
Revolving Loans Do Not Require a Present Borrowing Need
One of the biggest differences between installment and revolving loans is that you don’t have to borrow anything right now to open up a revolving account. With an installment loan, the entire amount is advanced up front, so if you need the money later, this is not the time to borrow, whether this need is known, likely, or just possible at some time in the future.
Once a revolving loan is opened, it is good until either you cancel it or you default upon it. There aren’t many good reasons to close a revolving loan account, so if you wish, you could keep it for life.
Some of the reasons why people may close them is if they just don’t have the discipline to manage it, and have given up hope on being able to attain sufficient discipline, or if they end up refinancing the debt in a revolving account, a line of credit as it is often called, by rolling it over into an installment loan, where the lender will often require the account to be closed as a condition of the new loan.
Other than that, revolving lines of credit are great to have in case you need them, even if you think that the chances of needing it is low. There’s more to this than just convenience, although it’s certainly very convenient to already have the loan you need approved and ready to use rather than having to apply for one when the need occurs.
When you do need to borrow, this often will mean that your financial circumstances have changed, your debt may have gone up, your income may have gone down, or your credit score may have dropped too far, and any of these conditions could easily disqualify you for a loan or force you into paying much higher rates for it.
Your approval and your rate for a revolving loan becomes decided at the time of application though, and no matter how bad things get, you still can use it at the terms agreed upon when granted, provided that you don’t default on it that is.
You could be living on the street and be in debt to your neck, and your credit score could be in shambles, but your revolving loan still is available to you, when you may not even be able to qualify for a payday loan. You still of course should be looking to use it responsibility, to keep it, although you could use it with no regard to paying it back if you really wanted to.
Ideally though you’d be looking to use this to help you through some more difficult times with a view of getting things straight in the near future, and revolving loans can be very helpful with achieving this if you have one available.
Revolving Loans Have Much More Flexible Payment Terms
With installment loans, a specified amount is to be paid on it each period, every week, every two weeks, every month, or whatever period that has been selected. This amount goes toward paying down the interest that has accrued during the period, as well as paying down a portion of the principal.
So, if your installment loan is spread over 60 months, you will be making 60 monthly payments and then it will be paid off. You can usually pay more and get it paid off sooner, but any money you put on it is gone and cannot be taken back.
With revolving loans, the only requirement is that you do not exceed your revolving line of credit.
If your credit line is $10,000 for instance, you can’t owe more than that, and the credit line won’t allow you to, as attempts to do so will be declined. The only way to go over is to be maxed out and then miss a payment, with the interest putting you over the limit, but at this point you are already in default, and that always needs to be avoided.
Other than that, there will be a certain amount that you need to make as a payment, but this need not be a net payment, as you can borrow the payment, and more, if desired.
It seems that few people have really thought enough about the ramifications of all this, including both borrowers and loan officers, but this all provides a huge amount of flexibility as far as how you may repay money that is borrowed.
If you lose your job for a while, you need not worry about making payments at all to your revolving loan if you cannot, and you can even borrow some extra provided that you have the room and are comfortable doing so. You can also distribute net payments on it however you wish, for instance make one net payment a year of a sizable amount, with an annual bonus for instance, or use whatever other arrangement you like.
You can also make payments on your revolving loan as aggressively as you want, throwing on every cent you can, because if a need arises for it, you can easily get it back. You can’t do this with installment loans because you cannot get this extra money paid on it back, it is on the loan for good.
This can result in an interest savings, where money set aside for reserves can be put on the borrowing loan instead of in a deposit product earning hardly any interest.
You also don’t have to worry about having to come up with this specific sum of money each period, although if your debt increases as a result, you do need a plan to reverse it at some point, and any strategy that involves borrowing beyond one’s capacity to repay is going to run into serious trouble, including using revolving loans.
You hear recommendations that people should have access to a certain number of months’ worth of income in reserve, and that’s a great idea for sure. Some people are only a paycheck or two away from having to live on the street, and this is what is sought to be avoided by these recommendations.
This ideally will be from your own resources, but if one does not have that in place, having the ability to borrow during these times can also protect you. The only difference is that you will have to pay it back, which does involve some risk, but that certainly is preferable to financial ruin right now.
Installment loans certainly have their place though, and sometimes you do want to lock in a rate and may also prefer a set repayment schedule, especially if you are of the sort that will tend to spend it if you have access to it. Sound budgeting skills and not borrowing without careful thought is always preferred of course.
Some lenders do not count revolving lines as debt and this may allow for people to extend their borrowing capacity, although this should only be done with proper regard to being able to handle this, and one should only exceed one’s capacity on a short-term basis with a clear plan.
Revolving loans can be a fabulous thing to have, and while installment loans provide for the present, revolving loans can provide both for the present and the future, and are often well worthy of consideration.
Revolving Loans FAQs
What is a revolving loan?
A revolving loan involves a lender offering a borrower access to a certain amount of money known as a credit limit, where borrowers may borrow any amount as desired up to this pre-determined limit. This is called a revolving loan because principal paid back will be recycled so to speak and allow these amounts to be re-borrowed later if needed.
Is a loan better than revolving credit?
Installment loans cover a specific borrowing need, where revolving credit allows us to use this lending product to borrow as needed from it for as long as the account remains open and in good standing. Sometimes there may be security needed for a loan, which will limit it to an installment loan, but you can do more with revolving credit so it would be preferable generally.
What does revolving interest mean?
All loans calculate interest daily based upon the principal amount owed at the time and the interest rate in effect. Revolving interest is simply interest calculated this way with a revolving credit product. Each daily closing balance will accrue a certain amount of interest, although this does tend to fluctuate more than with installment loans.
What is revolving credit examples?
The two main types of revolving credit are credit cards and lines of credit. Credit cards offer the advantages of earning rewards when you use them as well as an interest-free grace period when used to make purchases. Lines of credit do not have these advantages but typically offer lower interest rates and are generally preferable if you actually want to borrow.
Does revolving credit hurt credit score?
While paying off loans in a timely way can help your credit score and not going so will definitely hurt it significantly, with revolving credit, there is another aspect which can affect your credit score, which is the percentage of available credit used. As this percentage increases, it will put your credit score down, and the higher it is, the greater the impact.
Can term loan be revolving?
Term loans are never revolving in the sense that we use the term, which means that borrowed amounts that are paid back revolve back into available credit. Term loans can have their terms revolve though, for instance if you take out a loan that has a longer amortization than its term, where the term ends and a new term starts, allowing the terms to be adjusted.
What are revolving credit loans?
Revolving credit loans usually refer to borrowing with lines of credit, although we generally don’t call these loans as that is usually reserved for installment loans. Credit card borrowing also involve taking out revolving loans and both lines of credit and credit card borrowing involve revolving terms, where the ability to borrow remains after the loan is paid back.
What is revolving credit limit?
All revolving credit products come with a pre-established credit limit, which is required for us to know how much more we can borrow at any given time. Some American Express credit cards do not come with a pre-determined credit limit but they are not revolving products and the whole amount is due on the billing date. Credit limits are subject to review and can be increased.
Which is better line of credit or loan?
Lines of credit and installment loans are different products that serve different needs. Loans provide a one-time lump sum payment which is paid back within a specified time, and if that is what you are after, this sort of loan can meet your needs. If you expect to need to borrow again, and most people do, a line of credit will allow this without needing to re-apply for a loan.
How does a revolving account work?
A revolving account will extend a certain maximum amount of credit to a borrower, where may borrow any amount at any time up to the limit of the account. Interest will be applied to amounts owing, just like any other loan, but these amounts are more subject to change as more is borrowed or as more is paid back, with interest added to the account monthly.
What is a revolving period?
There aren’t really revolving periods with revolving accounts as far as the revolving part goes. You can borrow from it and repay the loan every day and the credit limit will continue to revolve each day. People usually refer to statement periods when they speak of revolving periods, which are one month in length, where interest is added and payments become due.
Editor, MarketReview.com
John’s sensible advice on all matters related to personal finance will have you examining your own life and tweaking it to achieve your financial goals better.
