What is Revolving Credit

One of the biggest hazards and debt traps in the economy today is revolving credit, also known as revolving line of credit, and it is very important to understand what exactly revolving credit is, and how to avoid falling into endless debt. Admittedly, it is a commendable task undertaken by banks to help out people who cannot afford to buy certain things, but the problem arises because most people do not know when to stop, and forget how to live within their means.

To understand the concept, you must take the example of a credit card since it works entirely on this concept. The whole point of getting a credit card is to pay for something you buy, in the future. You thus buy this item on credit and are required to pay the whole amount at a later date. The more you delay this repayment, the higher the interest rate that you will be charged. This is exactly why most people fall into debts because they do not know when to stop buying things on credit, and then end up being unable to repay all their credit card debts at the right time. As a result, the amount just keeps rising and rising.

Revolving Credits in Brief

It's basically known as open-ended credit, as opposed to closed-end credit. What this means is that an individual is given a credit limit for each month (for example, $10,000). Now he can buy things on credit and defer his payment till the end of the month. In one given month, his total credit spending cannot exceed the credit limit he has been given. You must remember that the credit limit an individual gets is dependent on his credit history and his credit score.

Now at the end of the month the individual has to repay all the credit he took, which works like a short term loan. The advantage of paying off the debt at the end of that very month is that he does not have to pay any interest. But in case the whole amount cannot be repaid, it will carry over to the next month, along with a certain rate of interest. The longer this balance gets carried forward, the higher the interest rate will rise. When the next month comes around and the borrowed amount is repaid, his credit limit goes back to the original count, and he is free to buy things on credit again. Thus, the total amount borrowed will never rise above the stipulated $10,000. This is what is known as revolving credit, and there are no fixed installments to be paid. The consumer only pays what he has borrowed whenever he wants, along with the rate of interest of course.

Closed-end credit, on the other hand, is vastly different from this method. Take the example of a home mortgage to understand the difference. In closed-end credit, the borrowed amount is fixed, the term of the loan (or the repayment date) is fixed and the interest rate is also fixed. None of these can change under any circumstances. Revolving credit is an open-ended loan, and the only thing that is fixed is the monthly credit limit of the individual.

Repercussions of Revolving Credit

It is believed that only about 40% of individuals in the United States pay their credit bills on time, and this leaves a massive 60% of users paying some heavy interest rates. These interest rates vary between 10% - 30%. While this is a useful service to have, users do tend to get carried away and keep deferring their repayments till a later date. Ultimately, a time comes when they cannot manage their debts anymore and then they have to declare bankruptcy. Needless to say, this is something that leaves a permanent blotch on the individual's financial history.

Credit card companies end up making a lot of money in the form of interest payments, but when these habits become excessive it takes a toll on the economy of the country. The recent recession was a result of the Sub-prime crisis and this was directly related to the stocking up of credit for people who had taken housing loans. The economy of the United States is strong enough to affect the entire world's economy, and hence the recession spread to almost all parts of the world. Revolving credit is not just limited to individuals in the form of credit cards. Even corporate companies have revolving credit accounts with the help of which they pay their daily expenses of operations.

It has plenty of advantages as well, and the biggest benefit is that the user can borrow money whenever he wants. This offers him great flexibility, and this is priceless. Moreover, the credit amount can be used for any purpose, unlike home loans, car loans and mortgages which need to be used for the very purpose for which they have been acquired. The convenience of not carrying around cash is also useful. But the downside, apart from the accumulating interest payments and the temptation to spend money you do not have, is the power given to the lender to change the credit limit and the interest rate as and when he sees fit. Owning multiple credit cards also has a detrimental effect.

This basic information should be enough for you to begin understanding this concept. There are many more details and intricate details about the concept that you can gather after consulting financial experts, and it is necessary to live within your means and to follow effective debt management techniques.