April 19, 2021
Being in debt can feel like you’re trapped in quicksand. Even though you struggle mightily, you could be just as likely to sink deeper into the mire as escape it, especially if your personal loan or credit card has a high-interest rate.
If you find yourself in this situation, the good news is that you’re not alone. The average American has a total debt balance of $92,727, nearly double that of the median salary.
Fortunately, there are strategies you can use to get out of debt faster and find financial freedom. But before you employ those, it’s important that you understand the basics of credit — specifically, revolving lines of credit — and this guide has you covered.
A line of credit (LOC), also known as a non-revolving line of credit, is a one-time provision of funds from a creditor — typically, a bank, government entity, or credit union — to a borrower. The extended credit is an agreed-upon, preset borrowing limit that the borrower can use at their discretion.
With any line of credit, the limit can be reached but can’t be surpassed. If the borrower requires additional funds, then they’ll need to attain an additional line of credit. Similarly, the borrower doesn’t have to use all of the money lent to them.
For example, if you need a $300,000 line of credit, your bank may give you a traditional loan that’s larger than the required amount. Depending on the bank, your credit score and current interest rates, they could say the minimum loan amount they could provide at a specific rate was $350,000. Were that to happen, you could either instantly pay off the extra $50,000 or simply use it as a financial cushion as you pay off your debts over the coming months.
A line of credit has built-in advantages, primarily in the form of flexibility.
As the borrower, you can spend the funds however you like. You may request a specific amount but not use all of it. Additionally, how you pay off the loan is largely up to you. You can typically adjust repayment amounts and the frequency of payments according to your budget — as long as it’s agreed upon by the lender.
Do you have the funds to pay off the entire outstanding balance in one go? You can do that. Or, if you prefer, you can just make the minimum monthly payments.
Typically, a line of credit can either be secured — where you offer some type of collateral — or unsecured, meaning it’s based solely on your current financial situation and credit score. Because collateral can help the lender recoup their losses should the borrower fail to pay back their loan, an unsecured loan will typically come with higher interest rates.
Interest is the cost of borrowing money from a lender.
When you approach a financial institution to acquire a loan, they won’t simply hand over a large sum of money. Financial institutions are businesses. Put simply, they have to ensure that the individual receiving the loan is capable of repaying it, and they have to turn a profit (to pay employees and continue to loan out more funds).
Interest is how they make money on a loan and cover the risk of lending out the capital. The less likely a borrower is to repay the loan, the higher the interest rate they’ll be charged.
And how do lenders know whether an individual is more or less likely to repay their loan?
That’s where credit scores come into play. This is a metric — on a scale of 300 to 850 — that rates your previous credit activity and gauges lender confidence in your financial behavior. Per the FICO® credit score model, it’s based on five key factors:
Payment history (35%).
Amounts owed (30%).
Credit history length (15%).
Credit mix (10%).
New credit (10%).
The higher your credit score, the more likely you are to repay your debts in a timely manner. And, as a reward for this good financial behavior, you’ll typically receive a lower interest rate. So, it pays to establish a good credit score.
A revolving line of credit is a type of loan that allows you to borrow up to a certain dollar limit. Then, once the debt is repaid, you can borrow up to that limit again without needing to undergo a loan approval process. According to Corporate Finance Institute (CFI):
“It differs from a fixed payment or term loan that has a guaranteed balance and payment structure. Instead, the payments of revolving debt are based on the balance of credit every month. Interest payments are calculated likewise; payments are based on the interest rate and balance and are often computed daily.”
A credit card is an example of a revolving line of credit. You can “borrow money” from your credit card company, pay the debt back, then borrow again.
When you apply for a revolving line of credit, the credit card company will evaluate your ability to repay the debt. For that, they’ll typically review your credit score, occupation and income level. This will give them a picture of your financial health and help them set a credit limit and interest rate. Once given a credit limit, you can then draw up to your limit each month. You may even be able to request a higher limit if you establish a positive track record.
It depends — largely on your credit and spending habits.
If you repay your balance in full and on time each billing cycle, a revolving line of credit in the form of a credit card can be beneficial since you won’t have to pay any interest. That revolving credit can provide you with access to borrowed funds immediately, helping to pay for unexpected or daily expenses.
Put simply, it gives you the ability to obtain an item now and pay for it later at little to no extra cost.
However, revolving credit can quickly turn into a debt spiral if financial disaster strikes or you don’t maintain healthy payment habits.
Failure to pay your balance in full and on time leads to accruing interest. If you take on too much debt too quickly, you may find yourself unable to pay off the interest on the credit card, let alone the original borrowed amount. This spiral may have a negative impact on your credit score, which will further impede your ability to acquire a new line of credit or a better interest rate.
This is why having tools to assess your current debt payments and payment habits is helpful, allowing you to see the beginning of a negative debt spiral before it critically impacts your financial health.
Both lines of credit and revolving lines of credit are based on agreements between a lending institution and a borrower. The lender provides access to funds that the borrower can then use.
With a traditional line of credit, the borrower has a set monthly payment and interest rate. It’s a one-time arrangement where the credit gets paid off over time, and the account is then closed.
A revolving line of credit is another type of credit line. Revolving credit gives you monthly access to a set limit. Once you pay off the borrowed funds and the additional interest, you’ll receive access to the maximum credit limit once more. Any unpaid monthly debt accrues interest that rolls over to the next month.
Are you paying off your balance each month on time? If yes, then a revolving credit account will typically help your credit.
Another factor that impacts your credit score is your credit utilization ratio, which is the total percentage of the available credit you’re using each month. So, if you have $10,000 credit available to you each month and you owe $4,000 in a given month, your credit utilization ratio is 40%.
Utilization ratio or “amount owed” across all credit cards and loans make up 30% of your credit score. By keeping this ratio low, your credit score will typically improve.
Are you stuck with an overwhelming, high-interest line of credit? If so, there are some steps you can take to get out of that situation:
Requesting a lower interest rate – Asking your lender for a lower interest rate won’t guarantee a “yes,” but there are reasons why a lender may agree. If you have landed a new job or received a pay increase, that may help convince the lender.
Paying more than the minimum payment – Ideally, credit card balances are paid in full each month. If you can’t do that, paying more than the minimum card payment will help reduce the debt quicker over time and will allow you to pay less interest in total.
Consolidating your debts – If you have multiple high-interest credit cards, it may be wise to consolidate all of your debts with an instant credit line app like Tally. Once you’ve downloaded the app-based credit line and scanned the credit cards to be managed, Tally analyzes your credit profile to see if you qualify for a line of credit with a lower APR than you’re currently paying.
Whether you have a traditional line of credit or a revolving line of credit, what’s most important is that you have the tools to manage and pay off your debt. Full and timely payments help reduce your interest payments and decrease the likelihood of getting trapped by negative debt spirals.
If you need help with that, Tally is here.
It takes only minutes to get started. Simply download the app, input your cards and let us go to work on helping you with your credit card management. We’ll create a strategy that matches your budget and financial goals, helping you take control of your credit card debt faster.
With Tally, saying goodbye to debt is possible.