How does revolving credit work?
Surely when you hear the term “revolving credit” for the first time, it will sound like something strange, invented by financial institutions or commercial establishments to empty your pockets and get you into debt. However, it actually refers to a basic financial product that is widely used in our daily lives, but which not everyone handles correctly.
What is revolving credit?
A revolving credit is basically a permanent credit limit, fixed by the financial institution that provides you with the amount, which is used repeatedly and is renewed as you pay off what you use.
The clearest example of revolving credit is your credit card. You have a limit that you cannot exceed at the risk of overdrawing. You have part of that limit at your disposal. And you can renew the total availability of your credit if you pay it off before the payment deadline.
Another case of revolving credit is the credit cards approved by department and self-service stores. They repeat the same dynamics as credit cards: a limit amount to be used that you can renew in full, as many times as necessary, as long as you pay the part of the credit you have used every month.
Then what is fixed term loan?
On the other hand, fixed-term loans are those that you can only use once, for example, mortgages.
Knowing how to use a revolving credit is a backup that improves and facilitates the management of your finances, as long as you never consider it as an extension of your salary. The consequences of an inadequate use of this product can lead you to get into uncontrolled debt, with the stress and lack of savings that this entails. Here are some advantages and disadvantages:
Advantages of revolving credit
Interest-free monthly payments: If you do not have enough money to pay cash. However, make sure they are products that you are going to use in the medium or long term, such as furniture or technological equipment.
Credit for up to 40 days: If you know exactly your payment and cut-off dates, you will be able to finance yourself for this time, which is very good in case of an emergency.
They can easily get out of control: If you are not 100% organized with your finances, you can start to fall behind with your payments, which will cause your debt to increase considerably, due to the interest you will be charged. Also, if you use them in an uncontrolled way, your revolving credit can become unpayable.
They can lower your score: Even though the finance company gave you a credit limit, bureaus will penalize you if you spend more than 50% of it, since it will consider that you are a person who does not know the limits. Also, if you have more than two of these credits, it will think you need a lot of mini financings, which is not good for your credit rating either.
The interest rates are very high: A revolving credit has interest rates that are much higher than those of other credits. And, in addition, these are cumulative, that is, they charge you interest on interest. Which means that if you do not pay the total amount you spent each month, your debt will grow a lot.
Payments are complex: Normally, a revolving credit allows you to pay a minimum balance, which frees up part of your limit and you can continue to use it. But, no one tells you that paying that will make the interest become unpayable and that the idea is actually to pay off the debt in full each month, to avoid this.
Golden rules for managing revolving credit
1.- Use them as a way to access promotions or to finance yourself momentarily.
2.- Pay them before the payment deadline, so that you are not charged interest.
3.- Do not have cash on hand, since you will be charged high charges and you send a bad signal to credit bureaus about the state of your finances.
4.- Forget about minimum payments, because that will only accumulate interest. The best thing to do is to pay the total debt at the end of your credit period.
If your debts are high, do not use your revolving credit until you are completely debt free.
I am Nikesh Mehta, owner and writer of this site.
I’m an analytics and digital marketing professional and also love writing on finance and technology industry during my spare time. I’ve done online course in Financial Markets and Investment Strategy from Indian School of Business. I can be reached at [email protected] or LinkedIn profile.