Revolving debt is the amount of money a borrower owes after using a revolving credit account. While they share some similarities, revolving debt and installment debt result from two different types of funding. To learn more about revolving debt, installment credit, and how they both may affect your credit score, check out the information below!
What Is a Revolving Credit Account?
How does revolving credit work? Revolving credit accounts allow people to borrow money continuously until they have reached a predetermined amount. There are many different products available when it comes to revolving credit, which means people of all kinds of credit history may qualify for one product or another.
To determine the details of a credit account, such as maximum funding limit, interest rate, and payback terms, lenders may request access to past credit reports. These reports will give the lender an idea of the potential financial risk they take by extending lines of credit to an individual.
What Is a Credit Limit?
Your credit limit is the total amount of funds you have to utilize on your revolving credit account. While setting up your line of credit, you and your creditor will agree upon a maximum amount of money you’ll have access to. Then, your overall credit limit will decrease as you use your available credit. Once you have paid back what you borrowed, your credit limit will reset to the original agreed-upon amount.
A credit card issuer or financial institution extending personal lines of credit will look at a borrower’s credit score, credit history, and other financial factors to determine their credit limit.
Common Examples of Revolving Lines of Credit
Two of the most popular forms of revolving credit accounts are:
- Credit cards
- Home equity lines of credit (also referred to as HELOC)
Check out more information below about these revolving lines of credit.
Credit cards are a common form of revolving credit available to most people. As a personal credit line, credit cards allow borrowers to spend money on virtually anything they want.
With a credit card, borrowers have access to a predetermined amount of funding they may use to make purchases whenever they want. Borrowers may access funds up to their credit limit until they either pay off their balance or wait for their billing cycle to renew.
The credit card debt that results in using your card is considered revolving debt. While borrowers have renewed access to their credit limit at the beginning of every billing cycle, their overall balance remains the same and grows as they continue to make purchases. This potential cycle of debt is why it is so important for borrowers to stay on top of their credit card balances.
Some credit cards come with extra charges, such as an annual fee. However, if you find yourself in a situation where you cannot pay or afford your annual fee, you can often work with your credit card distributor to lower or eliminate these charges. If your issuer cannot reduce your fees, they may be able to switch your revolving accounts to a different product that doesn’t have an annual fee. Keep in mind if you switch credit card products, you may lose access to certain perks or benefits you may have had before.
Home Equity Lines of Credit
A home equity line of credit is funding secured by the monetary value of the borrower’s home or property. With home equity credit lines, borrowers have a predetermined draw period. A draw period is a set period of time during which someone may make purchases using their credit line. When the draw period ends for a home equity credit line, borrowers have another predetermined amount of time, known as the repayment period, to pay off their balance.
Creditors often consider home equity credit lines as a second mortgage. Like a mortgage loan, a home equity line of credit is funding based on the value of a piece of property. If a borrower is still paying off their original mortgage and takes out a home equity credit line, they are responsible for paying back both revolving balances. Otherwise, the creditor would have the ability to assume ownership over the borrower’s home and force them to leave the premises.
How To Get Out of Revolving Debt
There are several ways to get out of revolving debt. How you go about taking care of your revolving account balances can significantly impact your credit score. To gain the most positive marks on your credit report, check out the helpful tips below.
Consolidate Your Debt Instead of Settling
Two ways of getting rid of your revolving debt would be to go through debt consolidation or debt settlement. With debt consolidation, you would take multiple forms of debt and combine them into one loan. That way, you are making one minimum monthly payment instead of several. Debt settlement is when you inform your creditors that you cannot pay back your balance and therefore must forgo your debt.
While debt settlement may sound like an easy out, you may find your credit score severely damaged if you go with this option. Credit bureaus consider debt settlement as a red flag indicator that you are a lending risk. To keep your credit score intact, you would always want to choose to consolidate your debt over debt settlement.
Come Up With a Debt Repayment Plan
Keeping your finances organized will help make your debt repayment less stressful. Try putting together a debt repayment plan you can stick to. Methods like the debt snowball or avalanche method have proven extremely helpful for many debtors.
Pay More Than Your Minimum Payment Due
To pay off your debt faster, try paying more than your minimum amount due each month. When you pay more towards your balance, you may find yourself with lower interest charges moving forward.
What Is Revolving Credit vs. Installment Credit?
There are several key differences between revolving credit and installment credit (also known as installment loans) that all borrowers should be aware of. Interest rate, funding distribution, and payback schedules are just a few of the major distinctions between installment and revolving credit. Once you understand the difference between installment loans vs. revolving credit, you can decide which funding product is better for you.
To start, revolving credit and installment debt can differ significantly regarding interest rates. Revolving credit usually comes with variable interest that may cause monthly payments to fluctuate, depending on the amount of revolving debt associated with the account. While an installment loan may have variable rates, many come with a fixed interest rate. Fixed interest means the rate stays consistent while the borrower pays back their loan in a fixed payment each month.
Revolving and installment debt also differ regarding the distribution of funds. Revolving credit gives borrowers access to funds continuously throughout their billing cycle, where they have the option to use or not use their available funds. Furthermore, interest rates only apply to what the borrower actually uses. Alternatively, lenders distribute installment loans in a lump sum all at once. The borrower is responsible for paying interest on the entire fixed amount.
Lastly, the way borrowers pay back revolving debt and installment debt are not the same. For example, after a borrower signs their revolving credit agreement, they will have to start paying back their balance at the beginning of their next billing cycle. Borrowers may never end up paying off the revolving debt in full if they continuously spend using their accounts. With installment debt, borrowers have a set schedule planned out at the beginning of their loan period that clearly maps out when they will make their final loan payment. Unless they refinance, installment borrowers won’t be able to access additional funding, which means their balance will only go down as they make their payments.
What Are Some Different Types of Installment Debt?
Borrowers may take advantage of several types of installment debt, also referred to as nonrevolving credit. Below are a few examples.
A mortgage loan is funding specifically meant to pay for the borrower’s home. Mortgages usually come with a variable interest rate, which means rates will cause monthly payments to fluctuate.
A student loan is funding students may use for their education-related expenses. Student loans may cover tuition, learning materials, dorm fees, and other students’ expenses. Like a mortgage loan, student loans also typically come with variable interest.
Auto loans are available for borrowers looking to pay for their vehicle. With auto loans, the equity in the vehicle is what secures the funding. So, if a borrower fails to pay back their auto loan, they risk their car being repossessed.
Personal installment loans are loans with monthly installments where borrowers can use the funding to pay for pretty much anything. Borrowers can take out personal loans to pay for medical bills, student loan refinancing, funeral costs, or other unexpected expenses they may come across.
How Does Revolving Debt Affect My Credit Score Compared to Installment Debt?
Both revolving credit and installment debt have the ability to affect credit scores. If you want to have a better chance of finding approval for better loan deals and other financial endeavors, it’s best to keep your credit as clean as possible, which means that you want your revolving or installment credit to have the most positive impact on your credit report as possible. The effects of having a bad credit score are something all borrowers want to avoid at all costs.
According to the current credit scoring models, there are five main factors that contribute to your credit score on your credit report. Below are all five factors with how revolving credit and installment credit may affect each one. Depending on your financial situation, you may find it easier to keep your credit intact by utilizing one of these funding options.
Your credit mix refers to the variety of financial accounts you currently have. Both installment loans and revolving credit can affect your credit score when it comes to credit mix. Installment loans affect credit mix because it lets financial institutions know that you have taken out a loan and owe money. Revolving credit accounts affect credit mix because it lets financial institutions know that you have access to a set amount of money, as well as how often you borrow from that set amount.
Again, both revolving debt and installment debt can affect your payment history. Since both funding options come with a repayment schedule, financial institutions look at how faithful borrowers are to that plan. When you make your revolving debt or installment debt payments on time, these actions positively reflect your credit report.
How much money you owe compared to the cash flow you bring in regularly also contributes to your credit score. This is called your debt to income ratio.
Furthermore, this category is also affected by what is called a credit utilization ratio. A credit utilization ratio is how much available credit a borrower has compared to how much they are currently using. For example, say a person has two credit cards with a $1,000 limit. If the balance on one credit card is $1,000 and the other is $0, then that person’s credit utilization ratio would be 50%.
Credit History Length
How long you have had financial accounts open also factors into your credit score. Say your credit card is your oldest financial account you should reconsider before closing, as long as you are able to keep up with your monthly payments. However, if your installment debt is your oldest financial account, you should not hesitate to pay off the balance. Paying off your debt is more important than keeping your installment loan account open.
New Credit Inquiries
How often you apply for new credit accounts is another factor that contributes to your credit score. While revolving credit does not require borrowers to reapply every time they use funding, an installment loan might. If a borrower needs financing in addition to their original installment loan amount, they will have to refinance or apply for another loan.