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Revolving debt is any debt without a set loan amount for a specific amount of time. Revolving accounts have an established credit limit, but you don’t have to follow a payment schedule or pay a fixed minimum amount each month.
Not all debts are created equal, and it’s important to understand how different types can affect your credit score. Two of the major debt types—revolving debt and installment debt—work in different ways, and learning the nuances of each can help you manage your debt and maintain a higher credit score.
How revolving debt works
The most common form of revolving debt is a credit card. With revolving credit, you have an established line of credit that you can draw on as often as you need to, so long as you don’t go over your limit. Your credit limit is determined based on your income, assets and credit history.
Here are the basics of revolving debt:
- Instead of paying a fixed minimum payment each month, your payments are a percentage of how much you borrowed that month. This means your monthly payment rates can change.
- You aren’t obligated to pay off the entire balance each month, but you’ll be charged interest on whatever balance you still owe. Revolving credit—such as credit cards—often have high interest rates.
- As you pay down your balance, you can continue to borrow more until you reach your credit limit. For example, if you reach your credit limit of $300, a payment of $100 will immediately allow you to borrow an additional $100.
Types of revolving debt accounts
Some types of revolving debt are backed by your assets, while others are not. The most well-known form of revolving debt is a credit card, which is unsecured. A home equity line of credit is another form of revolving debt, which is secured by your home.
These are the most common examples of revolving debt:
A credit card allows you to use any available funds at any time, as long as you continue to make minimum payments and don’t go over your credit limit. Carrying a balance on a credit card subjects you to accruing interest rates, whereas paying in full by the due date listed on your statement allows you to avoid interest charges.
Home equity lines of credit (HELOCs)
HELOC funds are commonly used by homeowners who need to cover a large expense, such as a home remodel. How much you can borrow is based on the equity of your home, which also serves as collateral. You aren’t required to pay a specific balance each month, but making payments replenishes your available credit (similar to a credit card).
The main difference between HELOCs and credit cards is that you can only access a HELOC during a defined amount of time, known as the “draw period.” It typically lasts around five to 10 years, after which the debt must be paid back during a “repayment” period and funds can no longer be withdrawn. A HELOC usually has far lower interest rates than a credit card, since it’s backed by an asset (your home).
Personal lines of credit
Very similar to a credit card, these are funds you can borrow as needed and repay immediately or over time. Personal lines of credit allow you to carry a balance that accrues interest as you continue to borrow. Interest rates are usually variable, so it’s tough to predict how much you’ll end up paying for what you borrow.
Lines of credit usually allow you to withdraw money in the form of a check or cash. If you need cash, a personal line of credit can be the more affordable option due to the high fees associated with credit card cash withdrawals. It’s also possible to receive a higher credit limit with a personal line.
Business lines of credit
Business lines of credit operate almost identically to personal lines of credit, except they’re used for business expenses. This type of revolving loan lets you access your funds as needed to finance continuous short-term purchases, such as inventory, equipment repair or filling in a gap in cash flow.
How revolving debt and installment debt impact your credit
Revolving debt and installment debt both impact your credit score. Having a mix of different types of credit accounts is one way to build your credit score. Successfully managing multiple kinds of credit is a good indicator to lenders that you’re a responsible borrower.
While late credit payments of any kind will always negatively impact your credit score, revolving debt in the form of credit cards can look riskier to lenders. This is because unlike installment credit, there’s no personal asset—like a house or a car—attached to it that can be repossessed if you don’t pay on time.
How revolving debt affects your credit score
Credit bureaus consider credit card debt to be one of the most reliable indicators of your risk as a borrower. Since lines of credit are one of the most common forms of revolving debt, it’s important to understand the ramifications it can have on your credit score.
Pay attention to these factors when managing revolving debt:
- High credit utilization ratio: The higher risk attached to revolving credit is mainly due to its impact on your credit utilization ratio. Credit utilization is the amount you owe versus the amount you have available to borrow. Your credit score can drop if you’ve reached your credit limit on all your credit cards—the FICO® scoring method ranks credit utilization as the number two factor used to measure your credit score (right after your payment history).
- Number of open revolving accounts: There is no specific number of credit cards that is considered the right number, but lenders do take it into consideration along with your credit history.
- Age of open revolving accounts: The older your revolving credit accounts are, the greater the benefit to your credit score. A longer history of responsible credit management indicates less risk to lenders.
How installment debt affects your credit score
Installment debt is typically considered less risky than revolving debt since it’s secured by an asset that you wouldn’t want to lose—whether that’s a new home, your car or your college tuition. It’s also considered more stable, so it has lower interest rates and less of an impact on your credit score.
Here are a few ways installment debt impacts your credit:
- Credit mix: Since having a mix of different credit types can boost your credit score, adding installment debt into that mix will help you diversify if, for example, you’ve only ever built your credit by using credit cards.
- Payment history: If you faithfully pay your installment debt each month for the agreed upon loan term, your credit score can go up substantially.
- Credit utilization ratio: You can use installment debt like personal loans to pay off high balances on your credit cards. This can significantly benefit your credit score because by using an installment loan to immediately pay off credit card debt, your credit utilization ratio is instantly lowered.
- Hard inquiries: Shopping around for installment loans like mortgages and auto loans triggers hard inquiries that lower your credit score.
Should I be carrying revolving debt?
While revolving credit can certainly improve your credit score, it requires careful attention in how you use it. If you have a habit of missing payments or using too much available credit, it might harm your score more than it would help it. It’s also possible for lenders to make a mistake and inaccurately report a missed payment on a revolving debt account.
Here are some helpful questions to ask yourself if you’re thinking about building your credit with revolving debt:
- Do I need to borrow a large sum of money quickly? While you can use revolving debt to finance a large expense, a key component of using revolving credit responsibly is keeping your credit utilization low. Your credit score can dip if you borrow too much too often, or if you’re close to reaching your maximum borrowing limit. It might make more sense to consider a personal loan with a fixed payment timeline instead.
- Will I make my payments on time? Payment history plays a crucial part in how your credit score is determined. If you can’t consistently pay for revolving debt on time every month, it might be best to avoid it for the sake of preserving your credit score.
- How is my current credit history? Even if you end up getting approved for a line of revolving credit, lenders could hit you with high interest rates if you don’t have a favorable credit history.
The credit repair consultants at Lexington Law can help you remove questionable negative items that might be harming your credit score. Since revolving debt can have a significant impact on your score, make sure you address errors on your credit report as soon as possible.