Revolving Debt vs Installment Debt
Understanding how repayment works for different types of debt is often the key to success.
Managing debt is essential if you want to maintain financial control. That means it’s critical that you understand how different types of debt work, so you can pay them off effectively. One of the key differences with debt is revolving debt vs installment debt. Credit cards are revolving debt, and they operate very differently from installment debts, like your mortgage or auto loan.
What is an installment debt?
An installment debt refers to any debt that has a set, fixed monthly payment. The amount you owe each month stays the same. This is what you see with loans, including:
- Auto loans
- Student loans
- Personal loans
- Home equity loans
- Debt consolidation loans
Installment debts are generally easier to manage because you know exactly how much you need to pay each month. It’s easier to budget around installment debts and you can set up things like AutoPay or Direct Debit to pay the bill automatically.
What does revolving debt mean?
Revolving debt refers to any debt that doesn’t have a set, fixed payment each month. The amount you’re required to pay each month varies based on your current balance. The more you owe, the more you’re expected to pay. This type of debt includes all credit cards, as well as a Home Equity Line of Credit (HELOC).
Revolving debts can be harder to manage because you don’t know exactly how much you pay. You can’t use Direct Debit because there’s no amount to set as the fixed payment. And Auto Pay can be tricky. If you overcharge and your minimum payment requirement is higher than you expect, it can lead to overdrafts and NSF fees.
There’s a certain art to managing revolving debt, and it’s often the key to maintaining finanical stability.
5 tips to ensure you stay in control of revolving debt.
Tip No 1: Payments always increase with your balance
Since revolving debts have no fixed payment like a loan would, the payments are based on a formula that’s usually outlined in your credit agreement. In most cases, it’s a percentage of how much you owe in total – for credit cards, that percent averages around 2.5% for most cards.
While this may not seem like much, it can really stack up when you have a significant credit line. At $5,000 you’re paying $125 – and people borrowing on that kind of scale often run into trouble because you end up with a few thousand dollars of debt on multiple cards. It can overwhelm your budget and leave you counting every penny.
Tip No. 2: Payment in-full should be a primary goal
Even though revolving debts like credit cards usually have a minimum required payment, there is no penalty for paying back everything you borrowed against the credit line during that payment cycle. Doing so usually limits or even eliminates interest charges that would be applied to the debt if you don’t pay it off during the first billing cycle.
It’s particularly that you don’t allow multiple credit lines to carry a balance from month-to-month. This usually means you end up paying more because you’re paying under multiple minimum payment schedules – each one building with interest charges each month you allow it to carry over. If you start seeing this cycle, take steps to reduce your debts strategically.
Tip No. 3: Be aware of high interest rates
Interest tends to be a bigger challenge with revolving debt because the rates tend to be higher since you’re borrow against an open credit line. So while loans can have rates as low as five percent or less, credit cards tend to have rates that can be fifteen percent or higher. The higher the rate, the more the debt costs.
Additionally, if you’re not paying close enough attention to Tip 1 and allow debt to carry over while you meet minimum payment requirements, most of each payment gets eaten up by accrued interest charges. This is why interest rates should help determine which debts you prioritize for payment in-full first in a good debt repayment strategy.
You also need to be aware that credit lines can have different rates for different types of transactions. For instance, taking out a cash advance on a credit card tends to have a much higher interest rate than the same card would apply on a normal purchase. Always be wary of using these types of transactions even though they’re averrable on your credit line.
Tip No. 4: Late payments wreak havoc
Most credit lines come with stiff penalties if you can’t repay them. Not only are there penalties for the late payment, the interest rate applied to the credit line usually gets penalized as well. You can double or even triple your rate by missing even one payment, and by law the penalty interest can be applied for up to six months even if you make every payment on time after that. You also need to be worried about late payments appearing on your credit report.
Tip No. 5: Credit lines affect your credit score
Credit utilization is the second biggest factor in determining your credit score after your credit history. Utilization is how much you use of your available credit lines. In general, your credit score starts to be affected negatively once you start using more than 30 percent of your available revolving credit, but ideally using 10 percent or less of your available credit is actually good for your credit profile.
Again, even though you have the credit line available, borrowing against it too much can be risky for your overall financial outlook.