Revolving Debt: Defined And Explained
Hanna Kielar5-Minute Read
September 10, 2021
It’s not unusual to carry debt. If you have an outstanding balance on your credit card, that’s considered revolving debt, and it’s the most commonly held type of debt in the U.S.
While debt is usually associated with negative outcomes like delinquent accounts and overdue bills, revolving debt can actually help build your credit score – if it’s handled correctly. Let’s take a closer look at how revolving debt works, plus how to use it to your advantage.
What Is Revolving Debt?
Revolving debt is any balance you carry from an account that allows you to borrow against credit. There are no specific loan terms for revolving debt, and it often comes with a variable interest rate.
While you’re ultimately required to pay back the money owed, revolving debt is not repaid based on a fixed monthly schedule. The most well-known type of revolving debt is credit card debt, which is why card holders can carry a balance if they need to.
What Are The Types Of Revolving Credit Accounts?
First comes revolving credit, then comes revolving debt. A revolving credit account is any line of credit that doesn’t require you to pay off your balance in full every month. Let’s check out the three most common examples of this type of account.
The first question most people ask when they’re approved for a new credit card is, "What’s my credit limit?" That spending limit dictates how much money you can borrow against that card, as well as your monthly payment.
Since credit cards are revolving credit accounts, borrowers are not required to pay off their full balance each month. However, they’re encouraged to pay it down to free up more of the credit line for the next month’s purchases. Don’t forget: Your credit card balance accrues monthly interest.
Personal Line Of Credit
Personal lines of credit are similar to credit cards in that both types of credit accounts provide a preset amount of monthly credit. Just like a credit card, these revolving accounts allow borrowers to spend money, pay off part of it, and carry that balance into the next month.
Home Equity Line Of Credit (HELOC)
HELOCs are different from the previous two types of revolving credit accounts in several ways. If you take out a HELOC, you’re borrowing against your home’s equity, which is used as collateral for that line of credit. If you mishandle the HELOC, you could potentially lose your house through foreclosure as a result.
This type of revolving credit also differs from credit cards because there’s a preset "draw period" for spending money. Once the draw period ends, you’re responsible for paying back the money owed, plus interest.
Revolving Debt Vs. Installment Debt: What’s The Difference?
Now that we understand how revolving debt works, let’s dive into installment debt. This type of debt requires borrowers to repay the money owed in fixed amounts over a set period of time. It’s especially important to follow the payment schedule for an installment loan. Multiple missed payments can result in heavy fines, damage to your credit score, foreclosure or repossession of any assets that were used as collateral to the loan.
Common examples of installment loans include mortgages, student loans, car loans and personal loans. Say, for example, you’ve been approved for a 30-year mortgage for a $350,000 home. If you take on a $280,000 mortgage with a 3.25% fixed interest rate, you’ll be expected to make a monthly $1,218.58 payment.
Overall, revolving credit is usually intended for shorter and smaller loans, while installment credit mostly applies to large purchases that require long-term payment plans. The same goes for revolving and installment debt; the former can and should be paid off quickly, and the latter is paid off in portions over time.
How Does Revolving Debt Affect Your Credit Score?
Revolving credit card debt plays a big role in determining your credit score because it directly impacts your credit utilization ratio. This metric represents the percentage of your available credit line that you’re using. That’s why carrying a high balance on your credit card can weaken your credit score over time.
Since your revolving debt status directly impacts your credit score, it’s recommended that you pay off debts quickly to avoid lowering your credit score. Missing payments or using too much of your credit line could also negatively impact your credit health.
How Can I Use Revolving Debt To Boost My Credit Score?
As mentioned above, revolving debt can help boost your credit score, but only if you adhere to the following guidelines.
- Make on-time payments. Not only will you avoid late fees by making on-time payments, but you’ll help your credit score by proving that you have a strong payment history. Nowadays, it’s easy to set up auto-pay features for credit card bills so that you never miss a payment.
- Keep your credit utilization ratio low. It may seem counterintuitive to not use your full line of credit, but keeping your credit utilization ratio low will help improve your credit score. It’s generally recommended that you keep your credit utilization under 30%, even if you’re carrying a balance from one month to the next.
Final Thoughts: Pay Off Revolving Debt Quickly
Although it can be tempting to make only the minimum monthly payments on a credit card or line of credit, it’s more beneficial to pay off revolving debts quickly. That way, you free up more of your available credit and potentially boost your credit score.
It’s almost too easy to let your credit card balance rise and fall into serious revolving debt. If you’re concerned about paying off your outstanding balance, you might want to review our strategies for consolidating credit card debt. Or, if you think you could benefit from a debt consolidation loan, visit Rocket Loans® for more information.
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