Can Revolving Credit Affect Your Score?

Posted on March 3, 2021 in Money

One of the most important aspects of financial health is credit score. The higher your credit score, the more likely you will be approved for loans and credit cards, the lower the interest rate will be on them, and the higher the total limit made available to you. 

The first step to maintaining a good credit score, or lifting one to a better tier, is finding and eliminating the issues that are hurting it. Some of these issues may be easy to find and address, such as being late on a scheduled payment, but others may not be easy to notice. Issues stemming from revolving credit, for example, can be harmful to a credit score but are not as easy to see. 

What Is Revolving Credit?

Before we can get into the potential problems that revolving credit can create, we must first define exactly what revolving credit means.  

The easiest definition is that a lender will extend a certain amount of available credit to someone who is then free to borrow repeatedly against it. The amount of credit that is permitted to use each month is a credit line known as a credit limit. The borrower is free to use as much or as little of that credit limit as they choose.  At the end of a statement period, typically monthly, the borrower will receive a bill for the balance of the credit used. If the balance is not paid off in full, then the balance is carried or revolved over to the next period, and interest will be owed on the remaining balance. As the balance is paid down, the available credit will go up. 

Revolving credit is typically used for small, low-cost purchases such as a new refrigerator or cell phone. It can also be used for monthly expenses such as gas or groceries. However, for larger purchases, such as a new car or college tuition, revolving credit is a bad idea. These large expenses would be better suited for an installment loan. These are almost the complete opposite of revolving credit. They are one-time lump sum amounts repaid, with interest, every month for a set time. 

How Does Revolving Credit Affect Credit Scores?

If used correctly, revolving credit can be greatly beneficial to your credit score, but it can also end up being quite harmful as well. Credit scores are broken down into five separate categories, and each one is impacted anytime credit is used. These are the categories and how revolving credit impacts them:

Payment History

Accounting for an incredible 35%, payment history is the largest and most important factor in calculating a credit score. Anytime that a scheduled payment is missed for a credit card or various revolving credit accounts, the credit score will be greatly impacted. However, consistently making payments before or by the due date will help to build a positive payment history that will strengthen the score over time. 

Amounts Owed

The second most important factor influencing a credit score is the amounts owed, which is responsible for 30% of the score. Anyone relying too heavily on credit will appear, at least to lenders, that they do not have enough money to keep with their expenses. 

Maxing out credit limits will negatively impact a credit score and dramatically. The easiest way to find out if you’re using too much credit is to find your credit utilization ratio. The formula for this is to simply divide the total outstanding balances you owe by the total amount of credit you have available. For example, if you have two credit cards with a limit of $5,000 and $3,000, the total credit available would be $8,000. 

Say you owe $2,000 on the first one and $800 on the second one for a total of $2,800 owed. The credit utilization ratio would then be the total owed, $2,800, divided by the total limit, $8,000, which would equal 35%. A good rule is to keep the credit utilization ratio under 30% at most and preferably around 10% in general. Anything above 30% could start to negatively impact the credit score overall, but anything 10% or lower will have a positive impact. It’s important to use revolving credit in some capacity but not to overuse it.

Credit History, New Credit and Credit Mix

These previous entries account for a staggering 65% of a credit score, so they are the most important factors, but that doesn’t mean these should not be ignored. Credit history accounts for 15% of the score, so the older the credit accounts, the better. The longer an existing line of credit exists, the higher the average length will be. 

Having several credit cards and other types of revolving credit can be beneficial for a credit score in the long run. That’s not to say that immediately opening up a bunch of credit lines is the best option, though. Having too many accounts opened within a short period of time will lower the average age of credit and will signal you may be financially desperate and need more credit. This is where new credit comes in and accounts for 10% of a score. 

Too much new credit can be a bad thing, but opening up a new line of credit every now and again can be helpful. The last 10% of a credit score goes to the credit mix of an individual. This one doesn’t have much to do with revolving credit specifically, but it’s important to keep in mind. Having experience managing different types of debt, such as revolving credit or installment loans, is an attractive quality to a lender and will help your score improve.

Tips To Making Revolving Credit A Benefit

Revolving credit often comes with a few benefits already. Most credit card lenders will offer programs that allow you to earn reward points or cashback anytime a credit card is used. Additionally, the monthly flexibility of a revolving credit line can greatly help with expenses in between paychecks. These lines must be used responsibly, though. Here are a few tips to keep in mind to have revolving help your score and not hurt it:

  • Make every monthly payment on time: Payment history is 35% of your credit score, so it’s important to make payments on time. If that is not enough of a motivator, the average credit card late payment fee is roughly $36 and some issuers also raise annual percentage rates on future purchases as an additional penalty. 

  • Keep the balance low: Just because you can spend 100% of the credit limit does not mean that you should. Revolving credit is not a loan, and it does not expire or lower if it’s not used. The credit utilization ratio is very important to a credit score and should not exceed 30%, or else the score will be impacted. It’s a good idea to spend what you know you can pay back by the end of the statement period. After that, interest rates will accrue, and the balance will increase while your credit score will decrease.

  • Only apply periodically: Having a credit line for various monthly expenses is a good way to juggle and maintain credit. Having a card used only for gas, for example, is a good way to use and pay off credit. However, applying for several cards at once can be detrimental, so it’s important to space out applications. Additionally, being rejected for a credit card can negatively impact your score, so be sure that your credit score is good enough to be approved before applying.

The Takeaway on Revolving Credit

Revolving credit will absolutely affect your credit score in monumental ways. Whether or not the impact is positive or negative will ultimately fall upon whether payments are made on time and how much available credit is being used.

Having a credit card, or other various forms of revolving credit, can be a great benefit to your credit score if you use it responsibly. Ideally, revolving credit should be used for purchases that you have the money for already and then repaid before the due date. This will help build up a positive credit history and can greatly benefit your credit score. However, missing payments and running up or maxing out credit lines can be extremely harmful so it’s important to keep the balances low and pay them back on time.

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