People have varying opinions about the word “debt.” Some people view debt as a tool; others are wary of it; still others treat it like a two-flush corn log, refusing to touch it with a 10-foot pole. Despite these widely diverging viewpoints on the topic though, debt is a necessity for most of us, and it’s not nearly as well-understood as it should be.

For example; an alarmingly high percentage of people I talk to don’t know the difference between fixed and revolving debt. Do you? If not, don’t sweat it… you’re about to.

Fixed Debt

Fixed debt, also frequently called “good debt” (though some experts would disagree), is a term given to credit that has a fixed term to be paid off, like a mortgage or student loan. With these loans, you’re given the money in a controlled manner (i.e. not from an ATM), and from then on it becomes all about paying it back. Once you’ve paid it back, you can’t just dip into it to spend more.

The reason this type of debt is often called good debt is that it’s usually used to purchase things that appreciate in value or make you richer, like a house or university degree. Again, it’s a hotly-debated topic, but I’m just giving you the facts.

The best way to recognize fixed debt is that you should be able to easily figure out the date that you’ll have the debt paid off. For example, you know with a 25-year mortgage that you’ll have it paid off in (duh) 25 years.

Benefits of Fixed Debt

Many of the things we take for granted in life (like a house, a car, an education) can only be paid for by borrowing, at least at first. Fixed debt makes these things possible, although I’d question taking on debt to buy a car.

Another benefit of fixed debt is that the interest rate is often lower than it is with revolving debt.

Dangers of Fixed Debt

It’s usually easier to borrow larger amounts of money in a fixed capacity than with revolving debt. Nobody’s ever going to give you a $300,000 credit card limit (unless you’re Richard Branson), but for a house? No problem!

Beyond that, lenders will often lend you more money than you can really afford to borrow – the maximum they’re willing to lend you is often more than you should ever be borrowing. It can become a massive burden for a family to owe so much, and is the cause of thousands of lost hours of sleep each year.

Revolving Debt

Also often called “bad debt,” revolving credit is the kind that allows you to dip back in and borrow more once you’ve paid off a portion of your balance. Think credit cards, lines of credit, etc. This type is dangerous because there is no set time period for it to be repaid. If you’re careless, you could wind up paying interest every month for the rest of your life.

Benefits of Revolving Debt

There honestly aren’t many. One of the closest arguments I’ve heard is that you can earn points by spending on your credit card instead of debit or cash. That to me is a flimsy argument; I highly doubt that people who spend to collect points, miles or whatever aren’t spending more each month than they would if they just paid cash for stuff.

So in that case, was it really worth it to collect $100 worth of miles in a year if you spend an extra $10,000 to do it?

The only benefit I can see in favour of revolving debt is that having access to it can improve your credit score over time. You don’t need to carry a balance to get this benefit, by the way, and you shouldn’t.

Dangers of Revolving Debt

Alright, so I couldn’t really wait until this section to talk about it. But here I go again: it’s very easy to rack up a balance with revolving debt buying things you don’t need to impress people you don’t like.

That, combined with the fact that revolving debt frequently has much higher interest rates than fixed debt (to the tune of like 20% per year), means that you’ll be paying thousands of dollars to your creditors each year as the cost of carrying a balance. These are dollars you could have saved for retirement or otherwise done something else useful with. Just say no to carrying a balance, and spend within your means.

Wrapping it Up

So there you have it, the difference between fixed and revolving debt. Hopefully you have a better understanding of the uses and dangers of each! Oh and by the way, if you’re looking to learn more about how to pay down debt faster, check out this post I wrote recently on a technique.