Finance

What Is Revolving Debt & How Does It Work?

March 16, 2023

If you need to borrow money, there are many financing options you can pursue: You can apply for a credit card, take out a loan, or see if you qualify for a line of credit.

All of these financing options fall into one of two categories: Revolving debt or non-revolving debt (a.k.a installment debt).

In this article, we’ll explain what revolving debt is and how it works. We’ll also highlight an innovative way to gain access to money without going into debt.

What Is Revolving Debt?

Revolving debt allows you to borrow money over and over again using the same credit account. You can borrow up to a predetermined amount, which is known as your credit limit. Your credit limit is based on your credit score, credit report, debt-to-income ratio, and other factors, like your credit utilization ratio.

Once you’ve spent up to your credit limit, you must repay some of your debt before you can borrow any more from your account. You may also have to make minimum monthly payments to stay in good standing with your lender.

How Does Revolving Debt Work?

What is revolving debt? There are several notable features of revolving debt, which include:

Revolving debt isn’t limited to specific uses – Most revolving credit accounts can be used for any type of expense you need help paying for—the money you borrow is yours to use as you please.

On the other hand, installment credit accounts can often only be used for specific purposes. For example, you can only use a mortgage loan to buy a house, an auto loan to purchase a car, or student loans to finance education-related expenses.
Revolving debt can be incurred as needed – While you have access to a certain credit limit with revolving debt, you don’t have to use it all. Even if your credit limit is $10,000, you can choose to borrow $1,000 at a time.

In contrast, installment debt gives you your full amount upfront. Thus, you’ll receive the entire $10,000 (and have to pay interest on it) whether you end up using it or not.
Revolving debt can be open-ended or closed-ended – Open-ended credit accounts remain open indefinitely until you or your lender decide to close them. Conversely, closed-ended credit accounts have set end dates when your account will be closed. At this date, your final payment is due.

While installment credit accounts are almost always closed-ended, revolving credit accounts can be one or the other.
Revolving debt has irregular payments – With revolving debt, your monthly payments are often calculated as a percentage of your current balance (which will likely vary from month to month). Your interest rate will also affect the amount you owe—revolving credit accounts often have variable interest rates. Meanwhile, installment loans have fixed interest rates and fixed monthly payments.
Revolving debt’s interest rates are often higher – Revolving accounts are known for having higher interest rates than their installment counterparts.

When comparing revolving debt vs installment debt, as you can see, revolving debt can offer more flexibility than installment debt. Many people prefer using revolving credit accounts to pay for ongoing living expenses, long-term home renovations, or recurring business expenses.

Types of Revolving Credit Accounts

The most common types of revolving debt are as follows:

Credit cards – Credit cards are the most popular type of revolving credit account. Credit cards are open-ended accounts that enable you to spend money online or in person. Credit cards are usually unsecured, which means they don’t require you to put up any collateral. As an added perk, many credit cards let you earn rewards or points as you make purchases. While credit cards have many benefits, they also have the highest interest rates of all revolving credit accounts.¹
Personal lines of credit – A personal line of credit is a revolving credit account that lets you borrow money for personal expenses. Personal lines of credit don’t use physical cards. Instead, your lender can simply send you a check or deposit money directly into your bank account. Thus, unlike with credit cards, you don’t need to make a purchase to access your funds.

The terms for personal lines of credit are negotiated between you and your lender. These credit accounts can be open-ended, closed-ended, secured, or unsecured.
Business lines of credit – Business lines of credit work similarly to personal lines of credit. The primary difference is that they’re meant to be used for business expenses. Since business lines of credit are made for businesses, you’ll typically apply for one using your business credit score, rather than your personal credit score.
Home equity lines of credit (HELOCs) – If you own a home, you may qualify for a HELOC. What’s the difference between a home equity loan vs HELOC? HELOCs let you borrow money from the equity you’ve built up in your home, rather than a lender. HELOCs are closed-ended accounts. You may have anywhere from five to ten years to borrow money from them.² Once your draw period is over, you enter the repayment period, which can last between ten and 20 years.

To avoid getting a denied HELOC application, you usually need to have at least 15% to 20% equity in your home.³ You may also need to meet certain credit score and debt-to-income criteria. Your home will be used as collateral for your HELOC, so if you don’t make your payments on time, you may lose it through foreclosure.

In contrast, a few examples of non-revolving credit (or installment loans) include student loans, personal loans, mortgage loans, and auto loans.

Is Revolving Debt Good?

Debt may have a negative connotation, but not all debt is bad. Some debt can help you achieve your financial goals faster than you could otherwise.

For instance, a business loan may be able to help you kickstart a lucrative business that allows you to earn a comfortable income for years to come. Likewise, a mortgage loan can get you into the housing market so you can start building equity.

Revolving debt can give you more financial flexibility when your cash flows are low. It can also be beneficial for your credit score if you manage it responsibly. If you want to improve your credit score using your revolving credit accounts, you should strive to:

Maintain low balances – While you can spend up to your credit limit, it’s not optimal for your credit score. Credit experts recommend keeping your revolving credit balances below 30% of your total credit limit at all times.⁴ For example, if your credit limit is $1,000, you should avoid carrying a balance over $300.
Make your payments on time each month – One of the most important factors that affects your credit score is your payment history.⁵ If you want to earn a good credit score, you need to make all of your minimum revolving debt payments on time. You can also save a lot of money by paying off your entire balance each month. Doing so will prevent you from having to pay costly interest on the money you borrow. With some credit card companies, you can prevent a bad credit score by paying double in case you missed a monthly payment.

Revolving Debt: An Example

To clarify how revolving debt works, let’s take a look at an example:

You open a revolving credit account with a credit limit of $10,000, an interest rate of 15%, and a minimum monthly payment amount of 10% of your total balance.
You borrow $2,000 from your revolving credit account, giving you a remaining credit limit of $8,000.
At the end of the month, your minimum monthly payment is $200. Even so, you decide to pay the full $2,000 to avoid incurring interest. Your credit limit is restored back to $10,000.
The next month, you borrow $9,000 from your revolving credit account, bringing down your remaining credit limit to $1,000.
At the end of the month, your minimum monthly payment amount is $900. You decide to pay back $3,000. Once you make this payment, your remaining credit limit goes up to $6,000.
Since you carry over a balance of $6,000, you owe $900 in interest, bringing your total balance up to $6,900.

How Do You Get Rid of Revolving Debt?

Over time, your revolving debt balances may become unmanageable, especially if you’ve racked up a lot of interest.

When it comes to how to get rid of revolving credit debt, you have some options. You can pay off your revolving debt gradually using the snowball method—paying off the smallest debt first—or the avalanche method—paying off high-interest debt first. You may also be able to pay off all of your revolving debt at once using a debt consolidation loan or by converting some of your home equity into cash.

Convert Your Home Equity to Pay Off Revolving Debt

Now that you understand revolving debt and how it works, you may be wondering if there’s a better alternative. If you own a home, there certainly is. A sale-leaseback program for homeowners can help you convert your home equity into cash without going into debt.

Once you choose a program, you can simply sell your home, continue living in it as a renter, and, with some programs, even reserve the right to buy it back whenever you’re ready or sell it on the open market.

In the meantime, you can use the money from your equity to pay for big purchases, ongoing expenses, or debt consolidation.

Key Takeaways

Revolving debt allows you to borrow money from the same credit account repeatedly over time up to a predetermined credit limit.
Once you’ve reached your credit limit, you must pay back some of your debt before you can draw from the account again. You may also have to make minimum monthly payments on your borrowed balance.
The most common types of revolving credit accounts are credit cards, personal lines of credit, business lines of credit, and home equity lines of credit.

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