Revolving debt is debt that occurs with a credit card or a home equity line of credit. It is called revolving because as the debt is paid off, the person can charge new debt to the credit card or line of credit. This is different than installment debt, where the amount is borrowed in one lump sum. Then, the debt is paid off month by month, with the borrower paying the same amount each month until it is paid off. Auto loans and personal loans are examples of installment debt.
With credit cards or similar debts, the money is not borrowed all at once. The lender will approve the borrower for a line of credit up to a certain limit. The borrower can use the credit card to make purchases as needed, up to the limit on the card. As long as there is a balance owed on the credit card or line of credit, there will be a minimum payment due every month. The amount of this minimum is calculated from the balance which is owed. The person can then either pay the minimum or more than the minimum for that month.
A borrower needs to be careful with revolving debt. It is possible to keep charging on the credit card so that the debt is never paid off. A vicious circle can occur, where the borrower charges more new debt to the credit card than what is paid off that month. As a result, the credit card can soon be close to being maxed out, that is, the balance on the card is close to the limit.
When using a credit card, it is important to try to pay off the balance on the card from a large purchase before using the card again. If a borrower’s balance on their credit cards is more than 30% of the total limit on the cards, the person’s credit score will be adversely affected. Missing payments to credit cards will also hurt the credit score. In addition, credit bureaus look at how many credit cards a person has. It is not necessarily bad to have many credit cards and other revolving debts. The problem occurs if it looks like the person is going to have trouble paying all that debt off. If the balances on all the cards are high, it will not be good for that person’s credit score.
Credit cards can be helpful to having good credit if they are used responsibly. The credit bureaus look for a variety of types of credit, such as home mortgages, auto loans, and credit cards. It is important to be current on all of these. Even one missed payment can hurt a credit score, and multiple missed payments can lower a person’s credit score drastically. The best way for a person to improve their credit score is to start paying at least the minimum payment before each due date and to pay more than the minimum whenever possible. Once a pattern of paying bills on time has been established, the credit score should start to improve. In addition, once the balance of all credit cards falls below 30% of the total credit limit, the credit score should improve even more.
Once a credit card is paid off, it is not a good idea to close it. It is better to keep it open and maybe use it occasionally for small purchases. The advantage to keeping the card open is that it will count toward the total credit limit of all the credit cards. Since the borrower should stay below 30% of total credit card utilization, this will be easier to accomplish if all credit accounts are kept open.
On the other hand, it is not so good to open more credit card accounts or lines of credit if a person’s credit score is already low. The credit bureaus look at the length of time that the accounts have been open, and the longer they have been open, the better. Opening too many new accounts will look like the person is getting in over their head with debt.
If a person’s credit score is poor, there are steps that can be taken to improve it. Paying bills on time and reducing the amount of revolving debt will help. Sometimes it is possible to take out an installment loan, such as a personal loan, to pay off some of the credit card debt. An installment loan usually has a lower interest rate and can be paid off more quickly. It is also easier to keep track of one installment loan rather than multiple credit card accounts.
It is important to keep a good credit score because it is used for evaluating a person when applying for a mortgage, insurance, or even a job. Small decisions about finances can have large repercussions later. It is to a person’s financial advantage to stay on top of their revolving debts and try to improve their credit score as much as possible.