Those looking to borrow money can choose from several financing options today. Thanks to a variety of finance options available today borrowing money has become easier. From renovating your home, managing your wedding expenses, or paying for higher education, there are financing options for every kind of goal. When it comes to borrowing money, two most common options include revolving credit and personal loans. Although each of these financing options may seem similar, they have their own benefits and differences.
Read more to understand the differences between revolving credit and personal loans.
What is revolving credit?
Revolving credit is a line of credit extended to you by financial institutions, such as banks or credit unions. A revolving credit facility allows you to borrow up to a set limit for a particular period. This is a flexible form of credit that is designed to give you quick access to the funds that you need. With this facility, you can utilise the credit as often as you like during the borrowing period. One great example of this type of a financing option is a credit card.
How does revolving credit work?
If lenders provide you with a revolving credit account, like a credit card, there will be a set credit limit on it. The credit limit is the maximum amount that you can use from that account. As you make use of the funds, your available credit limit is reduced. But every time you make a payment, your available credit is restored. Fees and interest charges on revolving credit could also affect the available credit. Revolving credit accounts are open-ended, meaning they do not have end dates for the credit. So, if your account is open, you can use the funds in it. Your minimum payment can change from month to month because it is frequently determined based on how much you owed at the time.
Types of revolving credit
Below are the types of revolving credit:
- Credit Cards: The most common form of revolving credit, allowing users to make purchases up to a predefined credit limit.
- Personal Lines of Credit: A flexible credit option with a preset limit, borrowers can access funds as needed and only pay interest on the amount used.
- Home Equity Lines of Credit (HELOC): Secured by the home's equity, HELOCs provide a revolving credit line for homeowners to use as needed.
- Business Lines of Credit: Similar to personal lines of credit but tailored for businesses, offering financial flexibility to cover operational expenses or unexpected costs.
- Overdraft Protection: Linked to a checking account, overdraft protection covers shortfalls, acting as a revolving credit line for emergencies.
How revolving credit affects credit score?
Revolving credit, like credit cards, can impact credit scores based on credit utilization. Keeping balances low relative to credit limits positively influences scores. Consistent on-time payments are crucial. High balances and late payments can adversely affect scores, indicating potential financial risk to lenders.
Now that you know how revolving credit loan works, lets take a closer look at how a personal loan works.
What is a personal loan?
A personal loan is an unsecured unsecured credit option issued for a specific amount and period. When a personal loan is approved, you will receive the entire loan amount in your bank account, which you can utilise and repay over the selected tenure. Once you have paid off the loan, the loan account is closed, and you will need to apply for a new loan if you need additional funds in future.
What are the differences between revolving credit and personal loans?
1. Interest rates
One of the primary differences between revolving credit and a personal loan is the interest rate. Revolving credit usually comes with a higher interest rate than a personal loan. Because you can borrow and repay funds as often as you like, the interest charges on revolving credit can quickly add up, and the interest rate is likely to be higher to compensate the lender for the increased risk. However, personal loans typically have a lower interest rate than revolving credit.
2. Credit utilisation ratio
The credit utilisation ratio is another significant difference between revolving credit and personal loans. This ratio considers the amount of credit that you use from the total amount of available credit. With revolving credit, the amount of credit available to you stays the same, as you use and repay the funds within the selected tenure. This means that if you continuously borrow within the limit without repaying it can negatively impact your credit score.
Contrarily, with a personal loan, your credit utilisation ratio declines with each on-time payment you make, which can improve your credit score in the long run.
3. Credit account
Revolving credit accounts are active for as long as you want, as long as you are up-to-date with your payments and do not exceed your credit limit. This makes it a flexible option for short-term borrowing and repayment needs. Compared to personal loans, revolving credit is accessible and convenient to use. It allows you to withdraw funds as and when you need them without having to go through an application process each time.
4. End-use and repayment
Personal loans are best suited for larger purchases and expenses. On the other hand, revolving credit is suitable for small expenses, that can be repaid over a shorter period. Personal loans come with fixed interest rates, which means that you know exactly what you will be paying and for how long. You can also plan your repayments effectively and improve your credit score with a personal loan.
Both revolving credit and personal loans can be useful financial solutions, depending on your borrowing needs. Understanding the differences between these two financing options can help you make an informed decision on which one to choose. If you need flexibility and quick access to funds, revolving credit may be an ideal option. However, if you require a more structured repayment plan or a larger sum of money, a personal loan may be the more appropriate option for you.
With Bajaj Finance Limited, you can avail of a personal loan of up to Rs. 40 lakh, which can be repaid over a tenure Of up to 96 months. You can also use our personal loan EMI calculator to estimate your monthly EMIs in advance and plan your repayment journey wisely.
