While revolving credit provides borrowers with flexibility, too much revolving debt can be crippling. With interest rates on the rise, the most vulnerable credit card holders can use some help.
Let’s look at ways of dealing with mounting revolving debt. But first, here’s a primer on revolving credit vs. installment credit.
A Closer Look at Revolving Debt
There are two main categories of debt: revolving and installment. Revolving credit lets you borrow money up to an approved limit, pay it back, and borrow again as needed. The two most common revolving accounts are credit cards and a home equity line of credit.
HELOCs are offered to qualified homeowners who have sufficient equity in their homes. Most have a draw period of 10 years, followed by a repayment period. A less common type of revolving credit is a personal line of credit, usually obtained by an existing customer of a lending institution.
Then there are credit cards, which became part of the American fabric in the 1950s, starting with the cardboard Diners Club card.
You can choose to make credit card minimum payments, pay off the entire balance each month, or pay some amount in between. If you don’t pay off the full balance when it’s due, your balance will accrue interest.
For example, let’s say you have a $10,000 balance on a credit card at 17% interest. If you pay $250 a month, it will take five years to pay off the balance — and you’ll ultimately pay $4,862 in interest. (Ouch.) You can use a credit card interest calculator to see how much interest you’ll pay on any balance.
If you continue to charge more to that credit card while making only minimum monthly payments, it’ll take even longer to pay off the balance.
That’s one of the quiet dangers of revolving debt: If you haven’t reached your limit, you can continue to borrow while you owe money, which adds to your debt and to the amount of interest accruing on it.
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What Is Installment Debt?
Installment credit comes in the form of a loan that you pay back in installments every month until the loan is paid off. The loan amount is determined when you’re approved. Think mortgages, auto loans, personal loans, and student loans.
An installment loan may have a fixed or variable interest rate.
Secured and Unsecured Debt
Now is a good time to touch on secured vs. unsecured debt (and why credit card debt is especially pernicious). Mortgages, HELOCs, home equity loans, and auto loans are secured by collateral: the home or car. If you stop making payments, the lender can take the asset.
An unsecured loan does not require the borrower to pledge any collateral. Most personal loans are unsecured. The vast majority of credit cards are unsecured. Student loans are unsecured, and personal lines of credit are usually unsecured.
That means lenders have no asset to seize if the borrower stops paying on unsecured debt. Because of the higher risk to lenders, unsecured credit typically has a higher interest rate than secured credit.
Which leads us to the common credit card trap: The average annual percentage rate (APR) for credit cards accruing interest was 20.40% in late 2022 … and rising. The APR on a credit card includes interest and fees.
Perhaps you can see how “revolvers” — borrowers who carry a balance month to month — can easily get caught in a trap. The average household of credit card revolvers owes nearly $7,500, according to recent data. Some owe much more.
On the flip side, “transactors” use cards for convenience and to gain credit card rewards. They pay off their balances each month.
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How Revolving Debt Can Affect Your Credit
Both installment and revolving debt influence your score on the credit rating scale, which typically ranges from 300 to 850.
Your credit utilization ratio is a big factor. It’s the amount of revolving credit you’re using divided by the total amount of revolving credit you have available, expressed as a percentage.
Most lenders like to see a credit utilization rate of 30% or lower, which indicates that you live within your means and use credit cards responsibly.
The most important element of a FICO® Score is payment history. It accounts for 35% of your credit score, so even one late payment — a payment overdue by at least 30 days — will damage a credit score.
And unfortunately, late payments stay on a credit report for seven years.
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Getting Out of Revolving Debt
Ideally, we’d all avoid interest on credit cards by paying off the balance each month. But if you do carry a balance, you have plenty of company. More than half of Americans carry a balance on active credit card accounts, recent data from the American Bankers Association shows.
If your revolving credit card debt has become unbridled, there are ways to try to corral it.
Consolidating high-interest credit card balances into a lower-rate personal loan will typically save you money. Most personal loans come with a fixed rate, which results in predictable payments, and just one a month.
Installment loans do not affect credit utilization. So using a personal loan to pay off higher-interest revolving debt will lower your credit utilization ratio (a good thing) as long as you keep those credit card accounts open. Yes, closing a credit card can hurt your credit score.
Homeowners using a home equity loan or HELOC to consolidate high-interest credit card debt can substantially lower their monthly payments. However, their home will be on the line, and closing costs may come into play.
Another method, cash-out refinancing, is a good move only when a homeowner can get a better mortgage rate and plans to stay in the home beyond the break-even point on closing costs.
A balance transfer card is another way to deal with high-interest debt. Most balance transfer credit cards temporarily offer a lower interest rate or a 0% rate. But they may charge a balance transfer fee of 3% to 5%, and they require vigilance.
Make one late payment on the new card and you’ll usually forfeit the promotional APR and have to pay a sky-high penalty APR. You’ll need to keep track of the day when the promotional rate expires so any balance is not subject to the high rate.
Balance transfer credit cards are simply another form of revolving debt and can restart that cycle. If you find that you’re creating new debt, you might want to learn to spend wisely while still budgeting.
A debt settlement company may be able to reduce a pile of unsecured debt. There are many drawbacks to this route, though.
You will usually stop paying creditors, so mounting interest and late fees will cause your balances to balloon. Instead, you’ll make payments to an escrow account held by the debt settlement company. Funding it could take three or four years.
Your credit scores will be damaged, there is no guarantee of a successful outcome, it can be very expensive, and if a portion of your debt is forgiven, it probably will be considered taxable income.
This and bankruptcy options are considered last resorts. If you do go with a debt settlement company, know that those affiliated with the American Fair Credit Council agree to abide by a code of conduct.
A credit counseling service might be able to help. The Federal Trade Commission advises looking for a nonprofit program, but it adds that “nonprofit” does not guarantee that services are free, affordable, or even legitimate.
Look into credit counseling organizations affiliated with the National Foundation for Credit Counseling, National Association of Certified Credit Counselors, or Financial Counseling Association of America.
The Department of Justice keeps a list of approved credit counseling agencies. Also check with state and local consumer agencies.
A credit card hardship program addresses temporary setbacks. Not all card companies have one.
The fastest ways to pay off debt call for creating a budget to plan how much you will spend and save each month.
With the avalanche method, for example, you pay off your accounts in the order of highest interest rate to lowest. The 50/30/20 budget works for some people: Those are the percentages of net pay allotted toward needs, wants, and savings.
A free app that tracks your spending and offers financial insights could be of great help.
Revolving credit offers flexibility but can devolve into runaway revolving debt. Credit card debt is especially pernicious, thanks to high interest rates charged to revolving balances. Debt consolidation, one approach to tame mounting revolving debt and the stress that comes with it, aims to lower your monthly payments.
Do you have high-interest credit card balances? You may be able to transfer that debt to a SoFi credit card consolidation loan.
A lower-interest loan will result in a lower monthly payment — and just one payment to keep track of each month. The personal loan is funded fast, has a fixed rate, and comes with no fees required.
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