Revolving Credit

Revolving credit is consumer credit extended under a plan that lets the borrower draw repeatedly, up to a limit set by the creditor, with the amount repaid becoming available to draw again. Credit cards are the familiar instance, but the category also covers unsecured personal lines of credit, home equity lines, overdraft lines and business lines.

Regulation Z's name for it is open-end credit, and the definition at 12 CFR 1026.2(a)(20) is a three-part test. The creditor "reasonably contemplates repeated transactions"; the creditor "may impose a finance charge from time to time on an outstanding unpaid balance"; and, third, "the amount of credit that may be extended to the consumer during the term of the plan (up to any limit set by the creditor) is generally made available to the extent that any outstanding balance is repaid". That third limb is the one the word "revolving" actually names, and it is the only one of the three that a fixed-term loan cannot satisfy. Anything that fails it is closed-end credit, which 1026.2(a)(10) defines as "consumer credit other than 'open-end credit' as defined in this section". The regulation recognizes two categories and no third.

A line of credit is a facility, not a category, and this is where readers get stuck. "Line of credit" describes the shape of the arrangement, that you are approved for an amount and draw on it as needed, and says nothing about whether what you repay becomes available again. Test it against limb (iii) and the answer falls out. A line you can draw down, repay and draw on again is revolving credit, and so open-end credit for every purpose in Regulation Z. A multi-advance facility in which each repayment permanently reduces what remains available is closed-end credit, whatever the marketing calls it, and it is disclosed under the closed-end rules instead. The name on the paperwork is not the test.

The statute and the regulation do not say the same thing, and the difference is exactly the interesting limb. The Truth in Lending Act's own definition, at 15 USC 1602(j), says an "open end credit plan" means a plan "under which the creditor reasonably contemplates repeated transactions, which prescribes the terms of such transactions, and which provides for a finance charge which may be computed from time to time on the outstanding unpaid balance", and adds that such a plan remains open-end "even if credit information is verified from time to time". Notice what is absent: nothing in that definition requires that repaid credit become available to borrow again. The replenishment limb is Regulation Z's addition, and it is what makes the regulatory category and the everyday word line up.

No payoff date is the structural consequence, and it changes what a payment is. A closed-end loan has an amortization schedule computed at signing, so each payment is a fixed amount and the last one is dated. A revolving account has neither, because the balance is whatever you have drawn and not yet repaid. So the required payment is computed each cycle from that balance by the creditor's own formula rather than scheduled in advance, and the published material on minimum payments sets out how that formula behaves and what federal law does and does not say about its size. It also means the account can persist indefinitely: nothing in the structure retires it.

The disclosure regime is a different chapter of the regulation. Open-end credit runs on 12 CFR 1026.5 through 1026.16, built around account-opening disclosures and then a periodic statement for each billing cycle in which there is activity. Closed-end credit is disclosed once before consummation under 1026.17 and 1026.18. That difference is why the terms of a card are re-presented to you monthly and can change with notice, while the figures on an installment loan are handed over once and never revised. It is also why the annual percentage rate does different work on each: on open-end credit it is derived from the periodic rate applied to the balance, which the published material on the annual percentage rate explains.

The category is one idea with several regimes on top of it. A credit card account under an open-end, not home-secured plan carries the card provisions, including the ability-to-pay rule behind a credit limit and the liability cap on unauthorized use. A home equity line is open-end credit secured by a dwelling and gets its own regime at 12 CFR 1026.40, including specific limits on what a lender may do to your line. An overdraft line is open-end credit attached to a deposit account. Each of those has its own published page. What they share is limb (iii), and the reason utilization ratios exist at all is that a revolving account has a limit to divide a balance by, which an installment loan does not.

The creditor approves a plan with a limit. You draw against it, and the balance accrues a finance charge under the plan's terms. Each cycle the creditor bills you a required payment computed from the balance. As you repay, the credit becomes available again, and the plan continues until either side ends it. There is no final payment written into the agreement.

A hypothetical example, in two versions of the same $10,000 facility, because limb (iii) is easiest to see by watching it fail.

Version A, revolving. Marisol draws $4,000, leaving $6,000 available. She repays $1,500, so the balance is $2,500 and the amount available is $7,500. Every dollar she repays comes back, and over ten years she could borrow far more than $10,000 in total while never exceeding a $10,000 balance. That satisfies limb (iii), so the facility is open-end credit.

Version B, not revolving. The same $10,000 approval, but structured so that the total she may ever draw is $10,000. She draws $4,000, leaving $6,000 she is permitted to draw. She repays $1,500, so the balance is $2,500, and the amount she may still draw is still $6,000. Repayment does not restore drawing capacity. Limb (iii) fails, so despite being a multi-advance "line of credit", this is closed-end credit and is disclosed under the closed-end rules.

Same limit, same draws, same repayment, two different bodies of law. The question to ask a lender is not what the facility is called but whether repaying restores what you may borrow.

Pros

• You borrow only what you need when you need it, and interest runs on the drawn balance rather than on an amount advanced in full at the start.
• Repaid credit becomes available again without a new application, which is what makes a revolving account useful for irregular or unpredictable costs.
• Paying in full each cycle can make the credit free of finance charges, which no installment loan structure allows.
• The account's terms are re-presented each cycle on a periodic statement, so changes and accrued charges are visible monthly.
• Having available credit that you are not using is the input that produces a low utilization ratio.

Cons

• Nothing retires the account. Without a schedule to do the work, the balance persists for as long as you keep making the computed payment.
• The payment is computed from the balance rather than fixed, so it moves and can give a misleading impression of what the debt costs.
• It normally prices above closed-end credit for the same borrower, because the lender committed to an amount it may never lend.
• The limit can be reduced or the plan changed on notice under the plan's terms, which is not a risk a fixed-term loan carries.
• A repaid balance being available again is a feature the borrower must manage, and it is the reason moving card balances to a loan without changing anything tends to produce both.
• The annual percentage rate on a revolving account does not capture an annual fee, so comparing it with a loan's APR compares two different measures.