What is revolving debt?

Behind every question about debt is a person who wants to make better financial decisions. If that’s you, today’s your day to level up.

Debt comes in many shapes and sizes. The type can tell you a lot about how to look at a particular debt and what that debt could do for you.

Revolving debt is one phrase you might run into. If you're picturing a revolving door in your head right now, you're already on the right track to understanding what it means. 

Ready to crack the code?  Let's explore revolving debt, how it works, and why it matters.  

Definition of revolving debt

When you're talking about revolving debt, you're talking about open-ended credit. The lender allows you to choose how much you want to borrow, up to a limit. Then you make payments against what you owe. As long as you make at least the minimum payment due on time each month and you haven’t hit your limit, you can continue borrowing.

The revolving door looks like this: borrow —> repay —> borrow —> repay —> 

This type of account is called a revolving credit line. If you have a balance, that’s called revolving debt.  

• As you spend, your available credit shrinks.

• As you pay down the balance, your available credit increases. 

Revolving credit accounts charge interest (except in unusual circumstances like a temporary interest-free promotion), but only on the part of your credit line you’re using. So, for example, if you have a $15,000 credit limit and you only spend $5,000 of it, you'd pay interest on that $5,000. 

Examples of revolving debt

What is an example of revolving debt? Here are three of the most common:

Credit cards

If you've ever used a credit card to buy groceries, get gas, or book a flight, then you've used revolving credit. 

Credit cards give you a limit you can spend against and, in turn, you're expected to make at least the minimum required monthly payments on what you owe. Part of your payment goes toward interest charges, and part goes toward the balance you owe. The smaller your payment, the longer it takes to reduce the debt.

The credit card issuer decides what your credit limit will be, based on your credit standing, income, and history with credit cards. Most credit card limits are between $200 and $50,000.

A credit card may be secured or unsecured. A secured credit card requires a cash deposit to open. If you fail to hold up your end of the bargain when it comes to paying your bill, the credit card issuer can keep your deposit.

Home equity line of credit (HELOC)

A home equity line of credit is a secured revolving credit line. This time, instead of a cash deposit, your home is the guarantee. The credit limit is based on your home equity, or the difference between what your home is worth and what you owe on the mortgage. Most lenders have a minimum and maximum loan amount, no matter how much equity you have. The amount you could borrow with a HELOC could be anywhere from $15,000 to several hundred thousand dollars.

You might be able to get a higher credit limit with a HELOC vs. a credit card or personal loan. And again, you'd only pay interest on the part of the credit line you use. 

Some common uses for HELOCs include home improvements and debt consolidation. 

Personal line of credit (PLOC)

A personal line of credit is a revolving credit line you can get at a bank, credit union, or online lender. It's sort of like a credit card, since you have a set credit limit you can spend against. And you only pay interest on the part of your credit line you use. 

Like credit cards, personal lines of credit may be secured or unsecured. 

How revolving debt works

Revolving debt works by letting you borrow against a credit limit as needed. The main differences between how different types of revolving credit work usually lie in:

• Credit limits

• What you need to get approved

• Borrowing against your credit line

• Repayment terms

Credit limits

You might get approved for a $15,000 limit on a credit card or personal line of credit (PLOC), whereas you might be able to borrow up to $150,000 with a HELOC. However, there are big differences in what it takes to get approved. 

Approval

With a credit card or personal line of credit, the main consideration is usually your credit score. Lenders may also look at your income.

HELOC lenders take those things into account too, but they’ll also look at how much other debt you have as well as how much equity you have in your home. 

Using your credit line

Credit cards let you draw against your credit limit by using your card (or the card number) to make purchases online or in stores. You could also take a cash advance from your credit limit if your card offers that option (but that’s typically very expensive). 

With PLOCs and HELOCs, you might get a debit card or paper checks, or have the option to transfer money into your checking account.  

Repayment terms

Many credit card accounts can stay open indefinitely if the account is in good standing. As long as your credit line is open, you can spend against it. If you have a balance, you need to make payments every month. The minimum payment is typically set to be so low, it could take you many years, or even decades, to pay off your balance (depending on how much you owe and whether you keep using the credit card). You could choose to pay more and pay off the balance faster.

PLOCs and HELOCs last for an exact number of years (typically 6-10 for a PLOC and 10 to 30 for a HELOC), and you’ll know this number when you open the account. The first few years are called the draw period. During the draw period, you can borrow, repay, and borrow more as often as you like, up to your credit limit. Your lender may allow you to make interest-only payments during this time, but if you do, your balance won’t go down at all.

When the draw period ends, you'll enter the repayment period. You’ll make equal monthly payments for a dollar amount that’s calculated to completely pay off your debt by the time the loan ends.  

Is revolving debt good or bad?

Debts could be considered good if they improve your financial situation or help you build wealth. A debt could be considered bad if it doesn’t give you a long-term benefit or have future value. This means that revolving debt could be either good or bad. 

If you use a home equity loan to remodel your home, improve your quality of life, and potentially increase your home’s value, that would typically be considered good debt.

If you use a credit card to buy restaurant meals that you can’t afford to pay off when you get the bill, that would typically be considered bad debt. 

What impact does revolving debt have on your credit score?

Can revolving debt affect my credit score? Yes, it can. But the impact depends on how you use it. 

First, three credit truths:

1. Any time you apply for a new credit account, your score could drop a few points. That’s because the lender is likely to do a hard credit check in order to process your application. Unlike soft credit checks, hard credit checks can affect your score.

2. Virtually all credit accounts are likely to have a negative impact on your credit standing if you fail to pay on time.

3. If you’re making your payments on time, and balances are steadily going down over time, that could have a positive impact on your credit standing.

Revolving debt and utilization

Credit cards have a unique impact. The amount you owe, in relation to your credit limit, affects your credit standing. This is called your credit utilization ratio. If your balances are low, your score could benefit. If your balances are high, that could hurt your credit standing. 

There’s no clear line between high and low utilization. It’s more of a sliding scale. A low balance, for example, could mean that you owe $500 on a card that has a $5,000 balance. A high balance could be a $4,750 debt on that same card. 

Loan balances, including PLOCs and HELOCs, aren’t scored the same way. Only credit cards.

Revolving debt and your credit: pros and cons

Revolving debt could have a positive impact on your credit standing if you:

• Make the required payments on time or early each month. 

• Keep your credit card balances low compared to your credit limit. 

• Also have experience with other kinds of debt, like student loans or a mortgage. 

On the other hand, revolving debt could have a negative impact on your credit standing if you:

• Apply for new credit often, since each new inquiry can ding your credit score. 

• Don't make your payments on time (or at all). 

• Carry a balance

Alternatives to revolving credit

Revolving credit isn't the only way to borrow. You could also get an installment loan. 

An installment loan lets you borrow a lump sum of money and then pay it back according to a set schedule. Installment loans have a fixed payoff date, and they can also have fixed interest rates, which means your payment stays the same for the entire repayment term. 

Examples of installment debt include:

• Personal loans

• Mortgage loans

• Student loans

• Car loans

A PLOC or HELOC is a revolving credit account during the draw period, and then an installment loan during repayment.

The biggest difference between installment loans and revolving debt is that the balance on an installment loan only goes down, while the balance on revolving debt can fluctuate depending on how you use your credit line. 

What's next

• If you're considering a revolving line of credit, think about what you need it for. For example, do you want to build credit, tackle a home improvement project, or consolidate debts?

• Estimate your budget and how much you need to borrow, based on your needs and goals. 

• Shop around to compare terms and different kinds of financing.