Revolving credit is a type of credit in which the consumer’s balance and minimum monthly payment can fluctuate, and where the cardholder usually has the option of avoiding finance charges by paying the last statement balance within the established “grace period.” This type of credit account (or line of credit) also has a predetermined credit/spending limit.
Credit cards are the most widely used type of revolving credit, with other examples being home equity lines of credit (HELOCs) and retail (department store, gas) cards.
Unlike a loan, a revolving account doesn’t automatically close when the account reaches a zero balance. It tends to remain open and available for use until the lender or the consumer chooses to close it.
[Related Article: The First Thing to Do Before Applying for a Credit Card]
Here’s an example of “revolving” a balance: If Amy has a Visa card issued by her bank with a $10,000 credit limit, she can go out and charge up to $10,000 worth of products or services. If Amy purchased $1,000 worth of tires for her car using her Visa card, she would receive a bill for that amount at the end of her billing cycle.
The bank gives Amy a few different repayment options. She can write a check for $1,000 and pay before the end of the grace period to avoid paying finance charges; she can pay the minimum monthly payment (in this case $38); or she can pay any amount between the minimum payment and the full statement balance. If Amy chooses to pay $300, she is revolving the other $700 to the next month. However, by doing so she will have to pay an additional $8.75 in interest on that $700 (APR of 15%, using a simplified calculation).
The following month, Amy doesn’t use her Visa card and she gets a bill for $708.75 ($700 + $8.75). Now Amy has to choose between writing a check for $708.75 to pay the balance in full and avoid further interest charges; paying the minimum monthly payment (now $34); or she can pay any amount in between $34 and $708.75. Amy decides to pay $500, and carry over the unpaid $208.75 to the next month.
The next month Amy continues to avoid using her Visa card, and gets a bill for $202.61, with the additional $2.61 being interest on the unpaid $208.75.
By revolving the balance, Amy is paying on time — which is good for her credit score — but she’s also paying interest each month on any unpaid portion of the balance.
More from Credit.com
- 11 Essential Credit Questions Answered
- Can You Really Get Your Credit Score for Free?
- The Ultimate Credit Report Cheat Sheet
- Credit cards