Debt Management Series: What Is Revolving Credit?

An integral part of debt management is ensuring that your clients understand how various forms of credit work, including revolving credit. Advisors, we’ve prepared this resource to share with your clients.

What is commonly referred to as revolving, or open, credit consists of credit cards, unsecured lines of credit, department store cards, HELOCs (Home Equity Lines of Credit) and all-in-one accounts.

• HELOCs and All-in-Ones are essentially secured lines of credit. They are based on the equity in your home and are generally offered at the lowest interest rates. They can be as low as prime or a small amount above prime. They don’t normally have annual fees, but some all-in-one accounts can have monthly banking fees. They are the most flexible lending options for mortgage debt. Generally, interest-only payments are allowed. While HELOCs do not have set amortization schedules, they are approved based on the borrower’s ability to repay the amount over a 25-year period.

• Unsecured Lines of Credit are often based purely on credit worthiness and ability to repay. They require a healthy credit score; normally you can’t have too much outstanding debt already and of course you need income. They are next in line after secured lines of credit in terms of cost. Rates are often a few percentage points above prime. Some lenders allow interest-only payments, and others might calculate a monthly payment as a percentage of the balance. For example, a credit card balance of $5,000 may require a payment of 2 percent of the balance, or $100 per month. There are not usually any annual or monthly costs to these lines of credit (although the borrower may have selected creditor insurance, which would charge to the account or direct to the borrower’s bank account each month). In either case, with no repayment term, the debt can be held indefinitely.

• Major Credit Cards are often one of the more expensive ways to borrow, with interest rates that could range anywhere from 9 percent to 24 percent on average. Most cards also come with an annual fee. There can be additional fees for any days the card balance is over the limit. A different rate of interest may apply to cash advances, and interest rates can be increased with little warning for reasons such as late payments. It should be noted that making only the minimum payment is never a very good long-term financial strategy.

• Department Store Cards are almost always the most expensive as far as interest charges go. Often charging a percentage ranging in the high twenties or even low thirties, or more

Revolving accounts also have a different effect on your credit score, both positive and negative. The amount of the balance owing as a percentage of the limit is taken into consideration. The closer the balance is to the limit, the lower your score. On the plus side, having a major credit card or unsecured line of credit helps to show a mix of different credit products in use, which is of benefit to your score.

This is the third article in our debt management series by Knowledge Bureau faculty member Marcia Elaschuk, DFA-Bookkeeping Services Specialist^TM

Additional educational resources: Debt and Cash Flow Management course and Elements of Real Wealth Management.

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