Although you have to pay back any money you owe, no matter what kind of debt it is, not all debt is actually created equal. Some debt has higher interest rates or variable interest rates that can change.
Some debt is installment debt, which is simply paid off in set installments. Both non-revolving (installment) and revolving debt affect your credit score differently and can affect your life differently—especially if you get in a hole of revolving debt that’s hard to get out of. Understanding revolving debt, and why it’s so easy to take on too much, is key to understanding how to get out of revolving debt.
The revolving debt definition can seem confusing. People often use the term “revolving debt” to mean credit card debt that is carried over from month-to-month—and while a lot of revolving debt is carried over and not paid off in full, that isn’t technically the definition of revolving debt. Revolving debt actually encompasses all debt that isn’t a set loan amount for a set period. Instead, the amount you owe can change as you pay some off and take on more debt—like a revolving door.
Revolving debt is actually incredibly common. According to the Federal Reserve’s annual report , there was $1.03 billion in outstanding revolving debt at the end of 2016. That’s up over 6% from the year before.
What Is Revolving Debt?
Revolving credit is simply credit that you can continue to draw on and use as long as the account is open—such as a credit card account. With revolving credit, the balance you owe and the minimum payments change with how much you borrow or pay off. And even after you pay off a credit card’s balance, you can simply borrow more on that same card.
Revolving debt is the debt you’ve accrued from those various revolving credit lines. The two most common types of revolving debt are credit cards and lines of credit, like home equity lines of credit.
With revolving debt, payments are not a set amount each month, but change based on your balance plus interest charges. You can choose to make the minimum payments required by the credit issuer or to pay off the entire balance immediately or to make some amount of payment between the minimum and the total balance. If you don’t pay off the full balance when it’s due, then you will ultimately end up paying more because your balance will accrue interest and finance charges.
For example, if you have a $1,000 balance on your credit card at 16% APR (the average credit card interest rate currently and you make just a 3% minimum payment monthly, then it’ll take 86 months to pay off the $1,000 and you’ll ultimate pay $1,590—$590 extra in interest.
Of course, if you continue to charge more to that credit card at the same time you pay off the existing debt, then it’ll take even longer to pay off. That’s one of the dangers with revolving debt: you can continue to borrow from your credit line while you still owe money, which adds to your debt and to the amount of interest you’ll have to pay. And if you don’t pay off the balance in full when it’s due, then the interest you owe will be added to your balance and accrue more interest.
What is Installment Debt?
Installment debt, by comparison, is debt that is a loan for a set amount with set payments and doesn’t change. Also called non-revolving credit, it can’t be used again when it’s paid off. Home loans and car loans are installment debt that you pay off in a fixed amount each month and that you can’t draw more credit from. Once the loan is paid off, it’s done and closed, and you’d have to reapply for a new loan.
When you take on installment debt, you agree to a set payment schedule and a fixed interest rate (or in some cases a known variable interest rate that is established in your initial contract). You then make your monthly payments until the debt—whether a car loan, mortgage or student loan—is paid off. For example, if you sign a $200,000 30-year mortgage loan at a fixed rate of 3%, then you’ll simply have to make set monthly payments of $843.21 until it’s paid off.
Typically, installment debt is considered lower risk than revolving debt and therefore has lower interest rates. You’re also able to borrow larger amounts, depending on your credit history and income. Often that’s because installment debt is also tied to the collateral that backs the loan, such as the car or the house the loan is for. It also affects your credit score differently.
How Installment Debt And Revolving Debt Affect Your Credit Score—And Your Financial Life
Both installment debt and revolving debt are factored into your credit score. In fact, your credit mix—meaning the different types of debt you carry—determines approximately 10% of your FICO score . If you miss a payment on either installment debt or revolving debt, it will affect your credit score.
However, because revolving debt, like credit cards, are considered riskier they can have a bigger impact on your credit score. They affect your credit utilization ratio —which means the amount of debt you owe in relation to the amount of credit available to you. So if you’ve maxed out all your credit cards, that could be a problem. However, using credit cards to take on small amounts of debt and then pay it off can help build up your credit score.
Installment debt doesn’t have as big an impact on your credit score. While having large existing loans can certainly affect the amount banks are willing to lend you, installment debt doesn’t affect your credit utilization ratio because there isn’t a larger line of of credit tied to the loan.
That means that in order to boost your credit score, you need to focus on paying off your revolving debt and not taking on more in the meantime. If you’ve gotten into a revolving debt trap, with your existing credit cards accruing interest and adding to what you owe, then there are a few options to get out of revolving debt.
How to Get Out Of Revolving Debt
Revolving debt can be hard to get out of, because the interest and finance charges keep adding to your balance. There are a few ways to get out of revolving debt, however. The simplest, though in some ways the hardest, is to make a pay-off plan. That requires you to plot out how much you can afford to pay each month and calculate how long it’ll take to pay off what you owe.
You also want to pay off the debt with the highest interest rate first and consolidate what debt you can to a lower interest rate.
In order to consolidate credit card debt, or really any kind of revolving debt, at a lower interest rate and save yourself money, there are basically two options: balance transfer credit cards or personal loans.
Both allow you to pay off your existing debt and then pay off the new debt at a lower interest rate, ultimately saving you money. However, balance transfer credit cards are simply another form of revolving debt and can reopen that cycle. Personal loans, though, are a form of installment debt.
Taking out a personal loan to pay off credit card debt is fairly straightforward. You can apply for a personal loan for any amount from $5,000 to $100,000 and use it for a variety of expenses—in this case: to pay existing debt. You then pay off the personal loan at a lower interest rate than you were accruing on your revolving debt.
Your interest rate will be based on your credit history, income, and financial obligations, but the average interest rate for someone with good credit is 13.5-15.5% . Just make your monthly payment and you’ll be on the path to being revolving debt-free.
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