What is Revolving Credit

There are numerous types of credit available in Canada, one of which is known as revolving credit. Known as a flexible borrowing tool, revolving credit is a great option for Canadians with all types of financial backgrounds.

So, what exactly is revolving credit? How does it work? And what are the pros and cons of adding revolving credit to your credit mix? Stick around to find out!

What is revolving credit?

If you have a credit card, you’ll likely have some concept of revolving credit, even if the term doesn’t sound familiar to you at first. Revolving credit is a type of financing that allows you to access money up to a predetermined credit limit.

Revolving credit works because once you repay what you’ve used, you can borrow it again instantly without reapplying for credit from your bank. If you don’t fully pay off what you owe after each month's billing cycle, your outstanding balance will accrue different levels of interest depending on the type of account.

Unlike revolving credit, other types of loans like car loans or student loans where the lump sum is deposited into your account are called instalment loans. Because you receive the entire cash deposit into your bank account, you'll be required to pay a fixed amount each month until the end of your repayment period.

In contrast, revolving credit accounts allow you to access funds on an ongoing basis, up to your credit limit.

What are the advantages and potential drawbacks of revolving credit accounts?

Revolving credit can be useful because it generally does not expire if you remain in good standing with your bank, primarily with a credit card. The longer you have a credit card, the more likely it is that your limit will be increased over time.

If you’ve shown your bank that through your years with them, you always reliably pay back your debts, they may reward you by increasing your limit. This in turn encourages you to use the account to finance large purchases.

So convenient, right? This simplicity also demands careful consideration. Because it’s easy to use and even easier to rack up your spending, revolving credit typically comes with high interest rates to discourage you from carrying a balance over long periods.

This interest rate on a credit card will be higher than the rate of a simple instalment loan. The average personal loan rate in 2023 is between five and ten percent a month, whereas a credit card will typically accrue 20 percent in interest every month. That can add up fast over time, so it’s important to responsibly manage how much you spend on a credit card throughout the year.

Also, you can’t just let your balance owed creep up. Monthly payments are required to keep you in good financial standing with your lender and avoid your account going into collections, for example.

Types of Revolving Credit in Canada

The most common kinds of revolving credit in Canada include:

Credit cards

An account like this helps you make bigger purchases that you can pay back over time without going to the bank to get a loan each time you are considering spending a significant, but not life-changing, amount of money. Credit cards also typically come with rewards, like cash back, points for various types of rewards, or miles to be used on airplane travel.

Personal line of credit

This type of account allows you to borrow money up to a certain limit during a set period that typically lasts three to five years. As you pay off what you’ve spent, the balance becomes instantly available again during the “draw period.” When this ends, you will repay what is outstanding by making fixed monthly payments into the account.

Home equity line of credit (HELOC)

A HELOC works just like a personal line of credit but uses your home as collateral. You borrow against your home’s equity, meaning its appraised value amount exceeds the unpaid balance on your mortgage. Most HELOCs let you borrow between 60 and 85 percent of your home’s equity during the draw period, which typically lasts five to 10 years. The repayment period lasts between 10 and 20 years.

Revolving credit can be secured or unsecured. A HELOC is an example of a secured line of credit because it is backed by collateral in the form of your house. The interest rate on a secured line of credit is usually lower because this type of account is not as risky for the lender.

What are the key features and components of revolving credit?

Four primary components of revolving credit are important to understand on your financial journey.

Credit limits

A lender will take your credit score, current income, and employment stability into consideration when they are deciding on your spending ceiling. Once they calculate it, you will be informed how much you can spend on revolving credit.

Interest rates

By having a good credit score, you may qualify for lower interest rates on your revolving credit. This means if your score shows good creditworthiness, you may pay less interest if you carry over a balance month to month.

Fees

A merchant may add a surcharge on payments made by debit or credit cards and apply it each time you use your card to make a transaction. The fee will be disclosed to a customer before a purchase is made. Banks may also apply annual or monthly fees to have the card.

Repayment terms

These terms are the rules set by your lender that determine how you will repay what you owe over time. Your lender will set out these terms when you open the account.

How does revolving credit compare to a line of credit?

A line of credit is a type of revolving credit that is typically used for projects where the total amount is difficult to estimate at the outset, like a home renovation. You can write cheques billed to your line of credit, something you can’t do on a credit card.

A line of credit has a certain pre-determined availability for its use and will close after several years. This won’t happen to a credit card, which you can renew after a pre-determined period (check the expiration date on your physical card).

What are the requirements and qualifications for obtaining revolving credit?

You will be required to submit a substantial amount of personal information to a lender so that they can verify your identity. When considering you for revolving credit, the financial institution will consider the information on your credit report, including your credit history, payment behaviour, and outstanding debts to all other lenders.

In Canada, banks typically require a minimum household income between $35,000 and $50,000 to approve a line of credit.

Will a revolving line negatively affect my credit score?

Yes, like all credit accounts, when you borrow money and do not make at least your minimum payment each month, you'll begin to collect interest charges on your loan balance. These non-payments will be recorded on your payment history, which, over time, can ruin your once-good credit score and put you into a cycle of debt.

Does disputing transactions on your credit card ruin your credit score?

So, if you dispute a transaction, what happens to your credit score? It depends. If the disputed transaction is removed from your report, there's a possibility it will increase your overall score. There's also a chance that no change occurs.

How can individuals use revolving credit responsibly to positively influence credit scores?

Here are a few strategies you can use to be sure you are using your revolving credit as responsibly as possible. By following these tips and tricks, you can lower your risk of potentially damaging your overall credit score.

Make your payments on time

Missed payments are the fastest way to damage your score. Set yourself up for success and arrange for your bills to be automatically paid each month.

Keep your credit utilization ratio low

Your ratio is calculated by dividing the amount of revolving credit you are using by the amount of revolving credit you have in total. Try to keep this ratio below 30 percent to prevent it from negatively impacting your score.

Leave your revolving credit accounts open

If you close a revolving credit line account, the amount of revolving credit at your disposal drops. This can drive up your credit utilization ratio, so even if you aren’t actively using an account at the moment, it’s best to keep it in play over time. By building a good credit history over time, lenders will see how well you manage debt and will be more likely to approve you for loans in the future.

Minimize inquiries made on your account

When a potential lender considers an application you’ve made, they may make an official request to view your credit report. These queries into your financial history can lead to a credit score decrease of up to five points.

These can add up if you make requests from multiple lenders because this suggests you are shopping around for a lender and could indicate you are financially squeezed. This raises red flags to financial institutions, as it suggests you may not be able to pay back your loan.

So, is it possible to remove negative things from credit reports, like multiple inquiries? It's important to note that you can remove inquiries from your credit report. But, the only way you can dispute a credit report is if you believe the inquiries were a result of fraudulent activities or proven administrative errors.

Ensuring your credit is diversified

Financial institutions want to know how you have managed different accounts over time. By having different types of well-managed credit in your financial portfolio, called a credit mix, lenders may consider you to have better creditworthiness, which positively impacts your credit score.

What does it mean if my credit card is restricted?

A restricted credit card implies that your ability to access funds is either temporarily or permanently limited. There are numerous reasons why your card could be restricted, such as suspicious activity being detected, exceeding your total credit limit, missed payments, and more. If you notice restrictions on your card, we recommend reaching out to your credit card company for more information.

What do credit repair companies do?

If your credit score has taken a dip in the last couple of years, you may want to consider partnering with a credit repair company. What credit repair companies do is take on tasks related specifically to your history to see if there are aspects of it that can be fixed.

For example, these companies can pull your files from the credit bureaus and analyze them before disputing any items or negative comments that don't appear correct. They may also be able to negotiate with credit bureaus on your behalf to help bring your score up. Note that these companies do require a fee, which is about $50 to $100 a month.

The Bottom Line

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Note: KOHO product information and/or features may have been updated since this blog post was published. Please refer to our KOHO Plans page for our most up-to-date account information!