What is Revolving Debt?
Revolving debt is also referred to as a line of credit (LOC). A revolving debt does not have a fixed payment amount every month. The charges are based on the actual balance of the loan. The same is true for the computation of the interest rate; it is dependent on the total outstanding balance of the loan.
How to Access Revolving Debt
Before granting a revolving line of credit to an applicant, a financial institution considers several factors that determine a borrower’s ability to repay. For an individual applicant, credit score, income, and job stability are the main factors considered. For a business, a financial institution may look at the company’s income statement, statement of cash flows, and balance sheet to determine the business’ ability to pay.
Types of Revolving Credit
There are various types of revolving debt, including signature loans, credit cards, and home equity lines of credit. The most common form of revolving debt is a credit card. Credit cards fall into the revolving category due to the responsibility of the cardholder to only pay a minimum payment each month
The other important part of revolving debt is there is no set amount owed, usually just a credit limit. It is different from other loans and debts since a fixed amount cannot be stated. Revolving debt is entirely dependent on the balance for a particular month, unlike personal loans and other loans that have a fixed principal amount. Revolving debt generally comes with higher interest rates than traditional installment loans, and the rate is usually variable rather than fixed.
Home equity lines of credit and overdraft protection for checking accounts are also considered revolving debt. This type of debt may have variable interest payments and fees, instead of a fixed interest rate that stays the same for the life of the loan.
Benefits of Revolving Credit
Revolving credit is useful for individuals and businesses that need to borrow funds quickly and as needed. A person or business that experiences sharp fluctuations in cash income may find a revolving line of credit a convenient way to pay for daily or unexpected expenses. It also allows the flexibility of buying items now and paying for them later.
Dangers of Revolving Debt
If used carelessly, revolving credit can spiral out of control.
Individuals, companies, and countries are at risk for financial difficulty if they have taken on too much debt. Also, borrowing too much and/or not paying on time will hit one’s credit report with potentially negative information. Bad credit ratings may send a negative signal to some banks and can pose problems in the approval of new loan applications.
Falling into debt over and over again can lead to some major effects such as loss of freedom, loss of cash flow, loss of time, and loss of opportunities, too.
Read More on Debt
To learn more about debt and credit, CFI recommends the resources listed below.