What is Revolving Debt and How Does it Work?

Revolving debt is a flexible form of borrowing that allows you to repeatedly access funds up to a set credit limit, repay those funds over time, and incur interest on the unpaid balance. Revolving debt has always been something I thought I should avoid at all costs, but that isn’t always necessarily the case. It can have several advantages as long as you can successfully manage your debt and pay your bills on time.

Let’s examine what revolving debt is and how to make it work for instead of against you.

Key takeaways

• Credit cards and lines of credit are popular examples of revolving debt.
• Revolving debt can be secured or unsecured.
• When used properly, revolving debt can offer flexibility and potentially help you improve your credit.
• Mismanagement of revolving debt can hurt your credit score and lead to financial strain.

What is revolving debt?

Revolving debt is a type of credit that doesn’t have a fixed number of payments. Instead, it allows you to borrow, repay, and borrow again up to a certain credit limit. Common examples of revolving debts include credit cards, home equity lines of credit, and personal lines of credit.

For example, my credit union provides me with an overdraft line of credit with a limit of up to $1,000. So when a bill comes in and there’s not enough in my checking account, my overdraft credit line automatically covers the shortage (for a fee, of course).

Revolving debt exists in both secured and unsecured forms. Secured revolving debt usually requires some collateral so that the lender can recoup its funds if you fail to pay the money back. A home equity line of credit is an example of this.

Most credit cards and personal lines of credit (like my overdraft line) are unsecured revolving debts. This type doesn’t require collateral, but it also may have higher interest rates.

How it works

A revolving debt is open-ended and has a set credit limit, which is the maximum you can borrow at any given time. You can either pay off the total amount borrowed each month or make payments on the outstanding balance. As you pay down your outstanding balance, your available credit increases for further borrowing.

You need to make at least a minimum payment each month on revolving debt. This is usually a flat amount or about 2% to 4% of your outstanding balance. If you don’t pay off the outstanding balance on your revolving debt in full each month, your lender will most likely charge interest on the balance.

That interest can get very high. For example, a federal cap of 36% for credit cards only applies to eligible military service members and dependents, though states may have general limits. Additionally, these interest rates are usually variable, meaning they can fluctuate depending on market conditions.

If you go over your credit limit or miss your monthly payment, you may have to pay fees and penalties on your revolving debt. Missed or late payments could also hurt your credit score.

How it compares to non-revolving debt

Revolving debt differs from non-revolving debt, also called “installment credit.” Non-revolving debt accounts, like auto loans or mortgages, close once you pay the balance in full. But when you pay off the balance on a revolving debt, that credit amount is available for you to use again. As shown below, other differences include interest rates, payment structures, and fees.

	Revolving debt	Non-revolving debt
Flexibility	Yes	No
Interest rates	Typically higher variable interest rates	Typically lower fixed interest rates
Borrowing limits	Open-ended with a limit	Fixed limit borrowed
Payment structure	Flexible minimum payments	Fixed monthly payments
Repayment term	Ongoing	Fixed
Common fees	Annual, late payment, over-limit, cash advance, balance transfer	Origination, prepayment penalty, late payment

Examples of revolving debt

• Credit cards: Credit cards are usually unsecured debts that allow you to make purchases, get cash advances, or transfer balances up to a set credit limit. They typically come with variable interest rates and potential charges like annual fees and late payment fees.
• Personal lines of credit: A personal line of credit provides you with access to funds to use for various personal expenses including debt consolidation. While personal lines of credit are usually unsecured, some lenders offer options secured by a certificate of deposit or savings account.
• Business lines of credit: Lines of credit for businesses provide access to funds for short-term needs such as inventory purchases or cash flow management. They can be secured by collateral, such as inventory or accounts receivable, or rely on the business’s creditworthiness.
• Home equity lines of credit (HELOC): A HELOC is a secured, revolving line of credit backed by your home. You can use the funds for various purposes, such as home improvements or debt consolidation. The lender usually provides a credit limit based on your home’s market value and equity, your credit score, and other factors.

Why would you use this type of debt?

When used properly, revolving debt can be a useful financial tool for individuals and businesses. Some key benefits include:

Flexibility: You can access funds when you need them without having to reapply for a loan each time you need money. While you’ll have a minimum requirement, your monthly payment amount adjusts based on your spending and account balance.

Convenience: Revolving debt like credit cards can come in handy for managing your cash flow when you need to cover large purchases or everyday expenses. As a self-employed independent contractor, I don’t have a regular paycheck coming in every two weeks, so I rely on credit cards to pay my monthly expenses, and then I pay those cards off monthly when income comes in.

Building credit: Using revolving debt could help improve your credit score as long as you make your payments on time and maintain a low balance relative to your credit limit. You want to make sure the balance on your revolving debt is less than 30% of your available credit. I use a spreadsheet to keep track of my credit card balances and credit limits to ensure that my debt stays below this threshold. I also set up automatic minimum payments so that I don’t miss a payment if I’m not ready to pay off the balance.

Potential rewards: Many credit cards offer rewards programs for earning cash back or travel points. Again, as long as you manage your credit card debt well, this could be a good way to save money or earn points on everyday purchases. I put all my household bills on my Discover it^® Miles, and then I use the points I accrue for either travel expenses or Amazon purchases.

Promotional interest rates: Several credit cards offer low- or zero-interest introductory rates for 12 months or more, which can be advantageous for large purchases or balance transfers. These offers may have more competitive rates than other forms of unsecured debt, but you should always check what you’ll pay after the promotion ends.

What are the dangers?

While revolving debt offers flexibility and convenience, mismanagement can lead to financial difficulties and long-term consequences – I know, I’ve been there. Some of the biggest dangers posed by revolving debt include:

Debt accumulation: Just because you have the available credit to buy something doesn’t necessarily mean you should use it. The convenience of accessing funds can lead to overspending if you aren’t careful. Accumulating too much debt can make it harder to pay off and increase your potential for defaulting.

High interest rates: If your credit cards have high interest rates, you could end up paying more for your purchases. Unless you’re disciplined enough to pay off your balance every month, your unpaid balance can accrue interest that compounds, grows your debt, and makes it harder to pay off.

Credit score harm: Your credit score could take a hit if you don’t effectively manage your revolving debt. Late or missed payments and high credit utilization can impact your ability to secure credit in the future.

Fees and penalties: Missing payment due dates can lead to pretty hefty late fees which add to your debt. Some credit cards also have pricey annual fees.

Stress and anxiety: Dealing with an insurmountable amount of debt can be really stressful and negatively impact your mental health, quality of life, and overall well-being.

How to qualify and apply

Qualifying and applying for revolving debt involves meeting specific requirements set by lenders. They usually consider these common factors to determine whether to approve you for a credit card or line of credit.

• Credit score
• Credit history
• Debt-to-income ratio
• Income and employment status
• Collateral (for secured debt)

Some companies let you know immediately if they approve you for a credit card or line of credit. If you get denied, the lender must send you a notice explaining the reasons and inform you of your right to request a free copy of your credit report from the credit bureau that supplied the information.

Tips for handling revolving debt

The key to making revolving debt work for you is to manage it responsibly to minimize interest, fees, unnecessary spending, and credit damage. Here are a few steps you can take to handle your revolving debt efficiently.

1. Create a budget

A budget can help you stay on top of your spending and monitor your expenses so you can better identify areas where you may be able to cut back. Try finding a budgeting app if you don’t want to manually manage a budget, and make sure you really follow it and adjust your spending.

2. Pay more than the minimum

If you only make minimum payments on your credit cards, it could take a long time to pay them off, especially if you pay high interest rates. Much of your monthly payment could go toward paying the interest, making it harder to reduce the principal balance.

3. Monitor your credit utilization

Monitor your credit utilization so that it stays below 30% of your credit limits. This can improve your credit score, which may enable you to take advantage of zero-interest credit card offers.

4. Automate your payments

By setting up automatic payments, you ensure that you never miss a due date. This helps you avoid late fees and potential credit score damage.

FAQ

Bottom line

Revolving debt is a versatile financial tool that can provide you with ongoing access to funds up to a predetermined credit limit. It can have advantages, and when used responsibly, it may help you build credit, manage cash flow, and handle unexpected expenses.

However, you should be aware of the dangers of revolving debt, such as high interest rates and possible debt accumulation, and consider its impact on your credit score and overall financial health.