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What Is Revolving Debt, and How Is It Different From Installment Debt?

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Revolving debt refers to credit that you can continuously draw on as long as your accounts are open and you haven’t hit your limit. Common examples of revolving debt are credit cards and lines of credit.

Installment debt, on the other hand, must be paid off over a set period of time with an agreed-upon repayment term and interest rate. Some common examples of installment debt are personal loans and student loans.

Both types of debt have pros and cons, and both can affect your credit. We break them down in further detail below.

What is revolving debt?

A credit card is the most common example of revolving debt. It lets you borrow a certain amount of money, but you only have to pay back a minimum percentage of it each month, plus interest (though interest payment can be avoided by paying in full). Because you’re not obligated to pay off the balance in full at any time, you can keep borrowing and re-borrowing from your card, as long as you don’t exceed the total amount of credit you’ve been granted.

For example, if you max out a credit card that has a limit of $5,000 and pay back $3,000, you can borrow that $3,000 back again. If you pay it all off, you’ll have access to the full $5,000 without needing to reapply for new credit.

Note that you can pay your credit card balance off in full every month, and it will still be considered revolving debt. In fact, it’s a good idea to pay your total balances off from month to month so that you don’t accrue any interest charges.

While having continuous access to extra funds can be convenient — especially in an emergency — revolving debt can come at a higher cost than installment debt. Credit cards and lines of credit usually come with variable interest rates that can be higher than what you might pay with installment credit like a personal loan or car loan.

Pros and cons of revolving credit
Pros Cons
Can borrow and re-borrow unlimited number of times as long as you don’t exceed the credit limit

Can be open-ended with no set time limit to pay back the full amount

May include a grace period for paying back funds without incurring interest charges

Might earn your rewards points, as with credit cards

Can be a useful way to manage cash flow if used responsibly

Can make repayment expensive due to high variable interest rates

May negatively impact your credit score depending on how much credit you utilize

May offer lower limits than other types of credit

May tempt you into spending more than you can afford to pay back

Because you have easy access to revolving credit, using it can be a convenient way to manage your spending. Using credit cards can also have the added perk of earning you rewards points.

However, you must be careful not to charge more than you can afford to pay back. Otherwise, you could end up owing hefty interest charges or even getting into burdensome debt that’s hard to pay back.

What’s more, having a high credit utilization ratio can drag down your credit score. If you’re looking to cover a large expense, such as a home renovation, you might be better off considering a personal loan than relying on revolving credit.

3 examples of revolving debt

Common types of revolving debt
Type How it works
Credit card The credit card issuer allows you to borrow up to a set amount. You’re responsible for paying back a percentage of whatever you borrow each month, plus interest if you do not pay off the balance within the grace period. These payment amounts, as well as the interest rate, may change from month to month.
Personal or business line of credit The financial institution gives you an unsecured loan from which you may withdraw funds as needed through a card, checks or transfers to a checking account. Interest rates may fluctuate and extra fees may apply for each transaction. Because it’s not secured by an asset, you could pay higher interest rates. Unlike credit cards, you’re unlikely to benefit from a grace period.
Home equity line of credit (HELOC) The financial institution decides how much you can borrow based on the equity you have in your home. You’re given a set time limit by which you must pay back the funds. Like a mortgage, if you default on your HELOC payments, you could lose your home. However, you could get a lower interest rate for using your home to guarantee the loan.

CREDIT CARD

If you don’t have any credit history, you could start building it by applying for a secured credit card through your current bank or credit union. This involves putting down a deposit that becomes your credit limit. Another alternative is to apply for a starter credit card with a very small limit. Once you’ve built up a positive payment history through either of these options, you can apply for a traditional unsecured credit card.

Consumers with strong credit, on the other hand, can open an unsecured credit card, perhaps one with a 0% APR promotional period for 12 months or more.

To find a card with the lowest possible fees and APR for you, do some comparison shopping. Once you identify the best card for your needs, you’ll need to fill out an application to determine if you qualify. To be eligible, you’ll need to meet requirements such as:

  1. Being a U.S. citizen or permanent resident, or have an Individual Taxpayer Identification Number
  2. Showing proof of income
  3. Submitting to a credit check

PERSONAL LINE OF CREDIT

To apply for a personal line of credit, you could start exploring your options at your existing financial institution. However, some banks and credit unions may not require you to have a checking account with them to qualify for a line of credit.

Once you identify where you want to apply, you’ll have to complete an application and provide supporting information such as:

  1. Pay stubs
  2. Tax forms, like W-2s

Be prepared for the lender to look at your credit score, payment history and debt-to-income ratio before they make their decision.

HOME EQUITY LINE OF CREDIT

Think of a home equity line of credit (HELOC) like a second mortgage — indeed, it’s a loan on a property that’s already been mortgaged. As a revolving credit line, it allows you to draw funds from a credit limit based on the value of your home. Interest rates are also variable.

Unlike a credit card, however, you have a set period of time to make charges, known as the draw period. Lenders may require an initial draw amount, and there can be a maintenance or annual fee. Once the repayment period begins — usually after about 10 years — you’ll have to pay off the balance within a certain time frame or risk losing your home.

How much home equity do I have? To get an idea of how much home equity you might be able to access, you should first appraise your home to determine its current value. Once you have this number, subtract your mortgage balance from it. The remaining amount is your available home equity.

[HOME VALUE] – [MORTGAGE BALANCE] = HOME EQUITY

To apply for a HELOC, lenders will want to see:

  1. Your current mortgage statements
  2. Paperwork from your original purchase
  3. Credit score
  4. Income

A home appraisal may also be required, though some lenders will waive this requirement. Keep in mind that a HELOC can come with significant closing fees in addition to the APR, so it’s important to shop around to get the best deal.

What is installment debt?

Student loans, mortgages, auto loans and personal loans are some of the most common examples of installment debt. With installment debt, you pay off a certain amount each month over a set period of time.

Assuming you keep up with payments, you can know exactly what date you’ll pay off your loan. Installment loans often have fixed interest rates that stay the same over the life of your loan, but they might come with variable rates, as well (such is the case with some private student loans, for example).

Because your monthly payments will remain relatively predictable, however, it may be easier to budget for installment debt than it is for revolving loans.

Another advantage of installment loans is that interest rates tend to be lower than for revolving credit. However, they may also be harder to qualify for.

Many lenders look for a strong credit score and steady income before approving you for an installment loan, such as a personal loan. If you can’t qualify for an unsecured loan, you might be able to get a secured loan by putting up collateral, such as your home or vehicle.

Revolving vs. installment debt: Key differences

Here are the key differences between revolving debt and installment debt:

  1. Installment debt must be paid back within a set period of time; revolving credit may be extended indefinitely
  2. Revolving debt tends to have higher interest rates than installment debt
  3. Installment loans do not count toward your credit utilization ratio, which is one factor that impacts your credit score

While having a set period of time to pay back your installment loan can keep you on track, some borrowers may prefer the flexibility of revolving credit and the ability to make just a minimum payment when money is tight. Depending on the product, a revolving credit account may be open indefinitely, but installment credit is only offered temporarily.

Getting out of revolving debt

When you borrow an installment loan, repayment is fairly straightforward. You owe a fixed payment every month, which you can set up on autopay. As long as you make this payment on time, you won’t have to worry about violating your loan agreement or falling behind.

With revolving debt, however, you’re typically allowed to make a minimum payment every month and carry your balance over from month to month. However, sticking to the minimum payment is not recommended, as it could cost you in interest charges.

If you owe $5,000 on a credit card with an 18% interest rate, for example, and make a $200 payment monthly, it will take over two and a half years to pay off your balance and cost you $1,314 in interest. That’s not counting any additional debt you add on top of that balance.

To avoid these interest charges, try your best to pay off your balance in full every month. This means not charging more to your credit card or line of credit than you can afford to repay. To do this successfully, it can help to make a budget and track your spending.

If you’re already dealing with revolving debt, here are a few repayment strategies that can help:

  • Come up with a debt payoff plan. Take a close look at your finances and figure out how much you can afford to pay on your debts each month.
  • Get motivated with the debt snowball method. List your debts in order from the smallest balance to the largest. Make extra payments on your debt with the smallest balance until you’ve paid it off in full. Move on to the next smallest balance and keep going until you’ve paid off all your debt.
  • Or save on interest with the debt avalanche method. With this method, you’ll target debts with the highest interest rates first. This guide on the debt avalanche explains more.
  • Consolidate your debt. You could consider borrowing a personal loan to consolidate your credit card debt. This can be helpful if you can qualify for a lower interest rate.
  • Try doing a balance transfer. If you can transfer your balance to a credit card with a 0% APR promotional period, you could save money on interest. Watch out for balance transfer fees, though.

How revolving debt can affect your credit

Revolving debt can either help or hurt your credit score, depending on how you use it. Your FICO Score — the most commonly used credit scoring model by lenders — is based on a number of factors, including:

  1. Your payment history (35%)
  2. Amounts you owe (30%)
  3. How long your credit accounts have been open (15%)
  4. New credit you’ve obtained (10%)
  5. Your mix of credit accounts (10%)

If you’re able to consistently demonstrate a credit utilization rate of less than 30% — meaning, you only use less than one-third of the revolving debt available to you — this can help increase your score. However, the variable interest rates that come with revolving debt could cause you to miss a payment, which would make your score decrease quickly.

Showing that you’re able to responsibly use a diverse mix of revolving and installment debt can give your score a modest boost since that accounts for 10% of it. Another advantage to taking on installment credit is that it doesn’t count toward your credit utilization ratio. The lower this ratio, the higher your score could be.

However, your debt-to-income ratio takes all your debts into account. If lenders feel you don’t have sufficient income to pay off your existing debts, this could affect your ability to get funding in the future. If you’re not sure what your DTI is, use this method to calculate your debt-to-income ratio.

 

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