Revolving debt consits of open-ended accounts, usually with variable interest rates, pre-determined credit limits and payments that are calculated as a percentage of the unpaid balance. Credit cards, home equity lines of credit (HELOC) and personal lines of credit are all examples of revolving debt.
Revolving Debt Explained
Revolving debt is the kind of debt that credit cards offer and is usually an easy way to get credit. It can be a useful tool when used with discipline.
Revolving debt is slightly complicated compared with a typical loan. There is no need to reapply for credit whenever you need more money. Instead, a lender, usually a bank, approves you for a credit limit, which is the maximum amount the bank will let you borrow. The bank decides what the limit will be by examining your income, assets and credit history. This lets the lender know how much debt you can afford to take on. The lender then issues you a credit card – the source of the revolving debt.
Once you have the credit card, you are able to use it to borrow up to your limit. For example, if your credit card has a $5,000 credit limit, that is how much debt you are able to put on that card, including any finance charges and interest. As you use the credit card to make purchases, they are subtracted from the credit limit.
As you repay the debt, the amount you’ve paid becomes available for you to borrow again. For example, if you charge a $500 purchase on your credit card and repay $100 the first month, you can borrow back the $100 immediately.
Certain lending products are usually revolving debts. For example, credit cards, home equity lines of credit and overdraft protection for checking accounts. Home equity lines of credit usually come with a variable interest rate, which means that the interest rate can change.
Revolving debt usually has an open-ended term. It has no end date; it is a continual source of a loan as long as you pay the appropriate fees and make your minimum monthly payments. The minimum payment for revolving debt is based on a percentage of the amount of debt, so the minimum payment can change from month to month.
Revolving debt is easy to get, but it is also very easy to abuse. It should only be used with discipline. Borrowing to make purchases that you really cannot afford, and then taking too long to repay the debt, spells financial trouble. As long as revolving debt is used with discipline, it can be a useful tool. Be sure to stay on guard and keep from abusing it, though.
The chief advantage of a revolving account is its flexibility. When the borrower requires money for purchases, he or she does not have to apply every time. A revolving account is reusable, up to its limit and for the length of its term.
Types of Accounts
Many revolving accounts are unsecured, meaning there is no collateral the lender can repossess if the account is not repaid as agreed. The exception is the HELOC, which is backed by the borrower’s property. Revolving accounts can be helpful to those attempting to build or rebuild a credit rating, but they can also harm a credit score if over-used (borrowers should not carry balances exceeding 30 percent of their credit limits), or if payments are late (over 30 past past due).
Lenders can terminate the account, however, for non-payment, exceeding the credit limit or other breaches by the borrower. Accountholders in good standing with creditors, however, can apply for better interest rates or credit limit increases.