A basic guide to understanding revolving credit

By Tiffany Alexy

Aptly named, “revolving credit” is a type of credit that stays open even when the loan balance is reduced to zero. The best example of revolving credit is a credit card. The user can make purchases up to a certain credit limit and access to this credit is allowed indefinitely, so long as payments are made on time.

Credit cards

However, according to Time.com, 65% of Americans carry a credit card balance. This means that for many U.S. adults, the definition of “paying on time” means paying the minimum due. While technically paying the minimum means you are paying on time, it also means that you will be paying more for your purchases. According to CreditCards.com, the average credit card interest rate is 15.07%. This means not only will you be paying far more than the original purchase price, you'll also be paying for a long time if you only make the minimum payment. 

Many credit card statements include minimum payment tables. If yours has one, check how long your balance would take to pay off if you only made the minimum payments. Even if you pay slightly more than the minimum, the added money could reduce the time until pay off significantly.

The other 35%...

For the 35% of Americans that don’t carry a balance, the methods of paying off monthly balances varies wildly. Now that online banking is readily accessible, those that are extremely debt averse may pay their balance almost immediately. Others may enroll in automatic draft, which pulls the statement balance due from their checking account each month. An important thing to note with auto pay is that it pulls the last statement’s balance from the account, which may not necessarily match up with the latest balance due on the card.

Paying off your credit card in full every month is the best option to ensure that interest doesn’t accrue on the debt owed. However, sometimes that isn’t always possible - especially for those working on digging themselves out of debt.

A quick “back of the envelope” way to calculate the amount of interest you will pay is to divide the credit card’s APR (annual percentage rate) by 12, to figure out the monthly interest rate. Then multiply that number by your balance. 

For example, if you had a balance of $5,500 at a 17% APR, you would be paying approximately $78 in interest the next month alone. That is just the cost of using borrowed money. With that illustration, it’s easily to see how quickly debt can snowball and how it can feel as if you are trying to get out of a hole that keeps getting deeper.

Paying off your debt

You might be wondering, “I’m working on paying off my credit card as much as possible. But how do I make it go faster?”

One option is to potentially transfer your entire credit card balance to a 0% APR card. If your credit score is high enough, you may qualify for special promotions credit card companies use to attract new customers. The key here is to be very clear about the terms and to know exactly when the interest will start kicking in. Some credit card companies also charge a fee for balance transfers - make sure to do the math to see if what you save in interest will be greater than the fee. 

Since the credit card offer will specify how long the 0% APR promotion will last, the prudent thing to do is to take the balance owed and divide by the number of months remaining in order to know the amount you need to pay each month. This ensures you will get the credit card paid before the interest kicks in.

Other types of revolving credit

Although credit cards are the primary example used for revolving credit, there are various other types of revolving credit, as well. Home equity lines of credit and department store credit cards are other cases of revolving credit.

HELOC

A home equity line of credit (HELOC) is a credit line secured against the equity you have built up in your home. In order to calculate your home’s equity, take the market value of the home, subtract any transaction fees, such as Realtor commissions and taxes, and subtract that number from your remaining mortgage loan balance. The remaining amount will be your equity. With a HELOC, the equity then serves as the collateral - essentially allowing you two different loans on your property.

A HELOC is considered revolving because it is line of credit rather than a loan (there are also products called home equity loans), however, it stays open only for a set amount of time. Given the flexibility of HELOCs, they are often used for big ticket items such as home renovations, new car purchases, etc. The amount can be borrowed as needed.

Department store cards

Department store credit cards (also known as retail credit cards) are another form of revolving credit. Often these cards offer discounts and rewards for frequent shoppers, so could help buyers save some money (as long as they are used responsibly). However, if you already tend to carry a balance on a regular credit card, opening a department store card is likely not a great idea.

Revolving credit is ideally used by responsible borrowers who pay off their balances each month. This ensures that they are maximizing the benefits offered (such as reward points) without paying hefty amounts in interest. Paying minimum payments is still considered paying “on time,” but when interest begins to accumulate, balances can balloon significantly.

About the Author

Tiffany Alexy is the owner of Alexy Realty Group. She occasionally contributes to the Self Lender blog on personal finance topics.

Written on February 13, 2017

Self Lender is a venture-backed startup that helps people build credit and savings. Comments? Questions? Send us a note at hello@selflender.com.

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