What is revolving credit, and how does it affect your debt?

In personal finance, revolving credit is a key concept that impacts short-term spending as well as an individual's long-term financial position. Understanding revolving credit and the consequences of it is critical for effective debt management and adequate financial planning.

What is revolving credit?

Revolving credit is a type of credit arrangement that allows borrowing money to a limit. Unlike an instalment loan, where the borrower borrows a lump sum and is required to pay it back according to specified terms, revolving credit allows more flexibility. In particular, as long as you stay within your credit limit, you can borrow money, repay it, and borrow it again.

Key characteristics

Revolving credit has 4 key elements:

• Credit limit: It is the absolute maximum amount you can ever borrow.
• Variable payments: Monthly payments will vary based on what the remaining debt balance is.
• Interest charges: Interest is charged on an outstanding balance. Interest is generally charged on variable rates.
• Refundable access: Once a debt is paid down, the available credit is reloaded to allow borrowing.

Impact on debt and financial health

1. Credit utilisation ratio: Your existing revolving credit balances in relation to your total credit limits are referenced in this ratio. Financial industry professionals suggest that for a good credit profile, this should remain below 30%.
2. Interest accumulation: Some revolving credit interest rates are higher than other forms of loans, and interest can add up quickly if bills are not paid in full, consequently accumulating debt.
3. Minimum payment: It keeps your debt repayment stretched out, while increasing the amount of interest that you ultimately pay, but maintains the account is in good standing. Paying more than the minimum would allow you to pay off debt sooner.

Advantages of revolving credit

• Flexibility: Access cash when you require it, eliminating the need to reapply for credit.
• Convenience: Useful for emergencies and cash flow.
• Credit building: Through responsible usage, you can improve your credit score and history.

Disadvantages of revolving credit

• Risk of over-expenditure: The temptation of easy access could increase spending.
• Interest costs: There could be charges on carrying balances that add to the cost of goods/services.
• Circumstance: Missed payments and large amounts have a negative impact on credit score.

Akshay Aedula, product and growth, CRED, explains how revolving credit leads us to enter into a debt cycle, “Revolving credit card bills is the first step into a debt trap. Cards and similar lines of credit let you borrow up to a predetermined limit, repay it, and borrow again as needed. Paying just the minimum amount and carrying the rest forward is often convenient, but it sets us up for dangerous habits.

Credit cards typically charge interest rates of 35–40% annually on unpaid balances, and interest begins accruing on every new transaction until the entire outstanding amount is paid. Most people don’t realise how quickly this adds up. Paying just the minimum may not hurt the credit score right away, but it silently drains your finances and leaves you constantly in debt,” he stated.

Best practicing for managing revolving credit

1. Spend control: When considering your expenses keep track of your purchases from the card.
2. Pay in full: To avoid interest fees, try and pay it off each month
3. Rectify errors: Regularly review your statements to ensure all charges are accurate and that you can identify any fraudulent charges.
4. Limit number of accounts: Fewer accounts to manage reduces the chances of escalating debt.

In conclusion, if used responsibly, revolving credit can provide an opportunity for flexibility and help produce results for your financial goals. It is important to understand that revolving credit has risks that may begin to develop into debt and credit issues if not utilized responsibly. By understanding how it works and utilizing good habits, revolving credit can benefit your financial health.

Disclaimer: Mint has a tie-up with fin-techs for providing credit, you will need to share your information if you apply. These tie-ups do not influence our editorial content. This article only intends to educate and spread awareness about credit needs like loans, credit cards and credit score. Mint does not promote or encourage taking credit as it comes with a set of risks such as high interest rates, hidden charges, etc. We advise investors to discuss with certified experts before taking any credit.