Debt has its positive side. Borrowing money to pay for things eliminates the problem of not being able to front money out of pocket. The credit card industry is worth billions of dollars thanks to the ability to lend money through the use of a simple plastic card.
Debt has benefits for the short-term. As debt grows and grows, credit scores end up suffering. A bad credit score brings forth a ton of problems. Revolving debt deriving from lines of credit or credit cards, in particular, can wreck havoc on credit reports and personal finances.
What is Revolving Debt?
Revolving debt seems like an odd way of describing a type of borrowing. Upon closing one’s eyes and imaging a revolving door of people going in and out of building without stopping, the description makes more sense. The credit limit on a revolving debt account fluctuates. In other words, if the maximum borrowing limit is $3,000, a person who pays $500 on a maxed out card now has roughly $500 in credit reopened to be accessible once again.
Installment loans do not work this way. This is why installment loans do not damage credit as much.
What is Installment Loan Credit?
Installment loan debt, unlike revolving debt, is finite. Borrowing $3,000 on a personal or secured loan means a one-time issuance of $3,000 is given to the borrower. He or she has a set amount of time in which to pay off the debt. Each month, as money is paid to reduce the debt, the balance goes down. Again, this type of loan is not a line of credit account. “Re-borrowing” on the previously paid debt is not possible.
So, why does revolving debt factor more negatively on a credit score than installment debt?
One problem with the presence of significant revolving debt centers on questions regarding how much of this debt is comprised of legitimate necessities. While it is true that people who are “stuck” for money may be forced to continually charge necessities, a great many people suffering from credit card debt woes are in the position they find themselves due to borrowing to cover lavish spending. Doing so does not exactly paint a fiscally-responsible picture of someone.
Therein lies one of the greatest curses associated with revolving debt: such debt creates a perception an individual simply lacks any financial control. Credit scores end up dropping dramatically to reflect a perceived lack of control.
The Credit Utilization Ratio
The credit utilization ratio refers to how much debt afforded to a borrower on a revolving debt account is actually being used. Anything more than 30% is going to reflect negatively on a credit score. Installment debt does not come with a credit utilization ratio since the amount, as previously noted, is finite. Hence, installment debt can not have as severe an impact as revolving debt.
A lesson is found in this explanation. Paying down revolving debt is a must for those who wish to improve their credit score.