Managing Your Revolving Debt

Debt is really an umbrella term encompassing many different ways to borrow money. Even if two people have the same amount of debt on paper, their situations are likely very different based on the specific nature of their individual balances. Understanding your debt and its implications is the first step to pursuing the right solution.

Installment vs. Revolving Credit

For example, it’s important to consider the differences between installment credit and revolving credit. When you take out a loan with regular set repayment terms, you’re taking on installment credit. When you take out a mortgage or auto loan, you agree to repay a given amount that does not fluctuate.

On the other hand, revolving credit is more open-ended. There will be an upper limit on how much money you can borrow within a given time period, but usage is continuous and dependent on the borrower’s behavior. Enrolling in a credit card is an example of taking on revolving credit.

Management of revolving credit has a significant impact on your credit score and overall financial health. Creditors factor in consumers’ credit utilization ratio (CUR), or the ratio of money you owe compared to your credit limits. Let’s say you have three credit cards totaling $10,000 in limits. Dividing the amount that you owe by this limit will reveal your credit utilization ratio. If you owe $5,000 across your three cards, your CUR is 50 percent. It’s generally accepted that 30 percent is the upper limit of an optimal CUR—any higher can negatively impact your credit score because it means your debt appears riskier to lenders.

Impact of Revolving Credit on Your Financial Health

At the end of the day, revolving credit stands to affect your credit score more drastically than installment debt. Why? Because there’s no collateral for credit card debt. If you stop paying your mortgage, you can lose your home. If you cease payments on your auto loan, ownership of your vehicle is at stake.

But credit card companies must use indicators like your CUR to gauge how much of your credit you’re using at any given time. Even making payments on time does not negate a high CUR in terms of sinking your credit score. Consider it this way: Your payment history makes up about 35 percent of your credit score; your CUR comes in close second at 30 percent.

Managing revolving credit is imperative for building the health of your credit score. But it’s also important for your overall financial health. It’s all too easy to keep raising your credit limits by opening new lines, just as it’s tempting to transfer balances between cards as a means to lower interest rates. Revolving debt can quickly spiral out of control, leaving consumers with maxed-out cards and no way to pay down their balances.  If you’re in a position where it’s difficult to make the minimum payments on loans, try to consolidate them, refinance student loans, or redo a mortgage for a lower rate.

Taking Control of Your Revolving Credit

While there’s no one-size-fits-all solution to eliminating revolving debt, there are options to explore. Bankruptcy tends to be the most drastic action and a legal last resort, so it pays to consider all the alternatives before making up your mind.

Debt settlement through a company like Freedom Debt Relief can actually lower your balance, allowing you to settle credit card debt for a fraction of the actual amount owed. Others choose to tackle debt on their own, utilizing budgeting and lifestyle changes—a valid option only for consumers carrying a lower amount of debt. Yet others refinance their homes, using this money to pay down credit card debts with higher interest rates while tacking on extra time on their mortgage repayment plan.

The Bottom Line

Too much revolving debt can quickly spiral out of control. Credit cards tend to carry interest rates around 15 to 20 percent, sometimes higher. It’s vitally important to manage your revolving credit as you go and address debt in a productive manner as soon as possible.