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:
- Mortgages
- 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 borrowing 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.
FAQs
Revolving credit allows borrowers to spend the borrowed money up to a predetermined credit limit, repay it, and spend it again. With installment credit, the borrower receives a lump sum of money that they must repay, in installments, by a specified date.
Is it better to pay off revolving debt vs. installment debt? ›
As you keep paying off your revolving balance on your credit card, your credit score will go up and you'll free up more of your available credit. Whereas with an installment loan, the amount you owe each month on the loan is the same, and the total balance isn't calculated into your credit utilization.
Is installment debt good or bad? ›
Examples of installment loans include auto loans, mortgage loans, personal loans, and student loans. The advantages of installment loans include flexible terms and lower interest rates. The disadvantages of installment loans include the risk of default and loss of collateral.
What is a disadvantage of revolving credit over installment credit? ›
Accrued interest. Revolving credit often comes with higher interest rates than installment loans, and if users carry a balance, they can greatly add to the cost of their purchases. Debt accumulation.
Why is revolving debt bad? ›
Revolving lines of credit generally come with higher interest rates than installment loans. That's particularly true if the line of credit is unsecured. It's limited. Typically, the credit limit on a line of credit is smaller than an installment loan.
Which debt should I pay off first? ›
Delinquent accounts.
If you have any debt that's highly overdue, it's best to start with that account. Delinquent accounts can have a substantial impact on your credit, just like accounts in collections, so those should be your first priority when paying off debt.
Is it bad to pay off installment loans early? ›
In most cases, you can pay off a personal loan early. Your credit score might drop, but it will typically be minor and temporary. Paying off an installment loan entirely can affect your credit score because of factors like your total debt, credit mix and payment history.
Can too many installment loans hurt your credit? ›
And having multiple installment loans will increase your account balances, which may also have a negative impact on your credit. Increase DTI ratio. Multiple personal loans will naturally increase your DTI ratio. Unless you are able to balance payments with more income, your DTI will increase.
Which credit card should I pay off first to improve credit? ›
Pay off high-interest credit cards first
Once you pay off the credit card with the highest APR, then you take that payment amount and add it to the minimum payment for the credit card with the second-highest APR, which can help you pay it down faster. Continue this method as you pay off each credit card account.
Should I pay off my credit card in full or leave a small balance? ›
It's a good idea to pay off your credit card balance in full whenever you're able. Carrying a monthly credit card balance can cost you in interest and increase your credit utilization rate, which is one factor used to calculate your credit scores.
Experts generally recommend using less than 30% of your credit limit. As you pay off your revolving balance, your credit score will go back up since you are freeing up more of your available credit.
What number range is considered a very good credit score? ›
740 to 799: Very Good Credit Score
Individuals in this range have demonstrated a history of positive credit behavior and may have an easier time being approved for additional credit.
Are credit cards considered revolving debt? ›
Credit cards are a common source of revolving credit, as are personal lines of credit. Not to be confused with an installment loan, revolving credit remains available to the consumer ongoing.
How do you avoid paying interest on revolving debt? ›
Ways to avoid credit card interest
- Pay your credit card bill in full every month.
- Consolidate debt with a balance transfer credit card.
- Be strategic about major purchases.
- Use a debt repayment method.
- Make multiple credit card payments per month.
- Tap into savings to pay down debt.
- Consider a personal loan.
Credit utilization ratio
Credit utilization looks at how much of your total available credit you have used, meaning your total credit across all of your credit cards and other revolving credit products. Experts recommend that your credit utilization ratio be no higher than 30 percent if possible.
How to get out of revolving debt? ›
Try the avalanche method
If you want to get out of debt as quickly as possible, list your debts from the highest interest rate to the lowest. Make the minimum monthly payment on each, but throw all your extra cash at the highest interest debt.
Which method for paying off debt is better? ›
Pay off your most expensive loan first.
By paying it off first, you're reducing the overall amount of interest you pay and decreasing your overall debt. Then, continue paying down debts with the next highest interest rates to save on your overall cost.
Should I pay off my Revolving credit? ›
Experts generally recommend using less than 30% of your credit limit. As you pay off your revolving balance, your credit score will go back up since you are freeing up more of your available credit.
Is it better to pay off credit card debt or collections? ›
Paying off your credit card debt in full is almost always the optimal route when looking at the issue from a credit score and financial perspective. By paying off the full balance owed, you will eliminate the debt and keep your credit report clean of any derogatory remarks related to the debt.
Which debt repayment strategy would be best? ›
Prioritizing debt by interest rate.
This repayment strategy, sometimes called the avalanche method, prioritizes your debts from the highest interest rate to the lowest. First, you'll pay off your balance with the highest interest rate, followed by your next-highest interest rate and so on.
