If you have been using a credit card or even doing your research for getting a card, you must have come across the term ‘Revolving Credit’. Credit card is a type of revolving credit account, as opposed to instalment credit accounts like personal loans and car loans.
In case of instalment accounts, you borrow a particular sum from the bank or NBFC only one time and pay it back in fixed instalments over a fixed period of time. On the other hand, a revolving credit account, like a credit card, allows you to borrow money, again and again, subject to your maximum credit limit. You can access the money available with you anytime.
How does revolving credit work?
To keep it simple, let us understand how revolving credit would work on your credit card.
Suppose you have a total credit limit of Rs. 1 Lakh and you purchase a product worth Rs. 15,000 on this card. Now, you still have Rs. 85,000 to spend. Once your bill gets generated for the given period, you will have to pay Rs. 15,000 in full. However, the card issuer also gives you the option of paying a ‘minimum amount’ and carrying forward or ‘revolving’ the balance to the next billing cycle. This way you can use the rest of the limit available to you.
You can continue using the available limit by paying the minimum amount due. As you keep making payments, it keeps adding to your available limit giving you more purchasing power on the card.
|AN IMPORTANT POINT TO NOTE|
Revolving or carrying forward the balance on your credit card attracts interest on the outstanding amount. Also, the new purchases you make would not be eligible for the free-credit period which means that they will attract interest from the very first day.
The only benefit of having access to a revolving credit account is that you can cover financial emergencies without waiting to apply for a loan and its approval. Finance charges and other fees must be kept in mind.
The Cost of Revolving Balance on Your Credit Card
The major cost of carrying a balance forward comes in the form of finance charges, also known as interest. Since a credit card is one of the costliest forms of borrowing in the market, continuously revolving the balance is not advised. It will cost you too much extra in the form of interest. Some banks may call interest rate as finances charges or charges on revolving credit.
Finance charges are applicable on:
- The outstanding balance carried forward after payment of the minimum due
- New purchases will also attract finance charges from the very first day (only when you are carrying a balance)
Also, the interest charges are compounded daily on credit cards, thus making it even worse. At the end of every day, the interest will be calculated on the amount that stands outstanding in your credit card account. For calculating the interest for the next day, the interest charged previously will also be added to the outstanding balance and it goes on like this.
Though initially, the amount would be negligible, it has the potential of growing significantly if you don’t pay on time, thus pushing you into a debt spiral.
How does Revolving Credit Impact your Credit Score?
There are many ways in which a revolving credit account impacts your credit score- when you open a new account and how you use the account.
Opening a New Revolving Credit Account (Credit Card)
- When you apply for a credit card, a hard enquiry is initiated on your profile which may lower your credit score.
- When you open a new credit account, it will lower the average age of your credit history and it may have a slightly negative impact on your score.
- When you open a new account different from those you already have, it creates a good mix of credit which improves your credit score.
Usage of Your Revolving Credit
- When you revolve your credit card balances to the next billing cycle and keep spending more money on it, your credit utilization ratio would shoot up which negatively affects your credit score.
- Even if you pay only the minimum amount due per month, this would not be marked as a missed payment or late payment and hence, you can build a good history of on-time payments. However, if you miss the payment altogether, it will severely impact your score.
Also Read: How Credit Cards Affect Your Credit Score
Things to Keep in Mind
Credit card is a type of revolving credit account and using such accounts are usually expensive. But emergencies can strike anytime and you may have to resort to such financial means. Here are a few tips that will help you.
Spend as Little as Possible
When you have carried forward your balance to the next cycle, the outstanding amount will attract interest and the new ones will do too, starting from the day of purchase. This will add on to your costs. So, you must control your spending as much as possible. Piling up new purchases on top of your existing ones will make it very difficult to pay off the debt.
Try to Pay More than the Minimum Due
The more outstanding amount you clear, the lesser interest you will have to pay. Also, the minimum amount may be a lot less than the total due and if you can afford to pay more than that, you must.
Pay off the Balance Quickly
Emergencies do strike and you may need to carry forward your balances. However, you must manage your cash flow in a way that you do not have to go overboard. Plan in advance and pay off the balances as soon as you can. This will save you a lot of money in the long run.