Revolving credit is a method of financing subject to automatic renewal on a regular basis.
It consists of a capital that can be used freely - a part or all - in a certain time, for example, a month. After this period, the available balance will be the same as at the beginning of the previous period.
Interest payable on revolving credit is calculated solely based on the amount used. That is, the less the purchases financed with this loan, the lower the debtor's expenses. However, creditor entities usually require a minimum consumption. Otherwise, they charge a commission or penalty.
The most representative example of this type of financing is the credit card.
Advantages and disadvantages of revolving credit
Among the advantages of revolving credit are:
- The debtor sets a limit on his spending, which is known as a line of credit.
- As it is freely available, the user can choose to consume an essential minimum. This way, you will have to pay less interest.
However, it is necessary to note some disadvantages of revolving credit:
- The interest rate charged on these loans is higher relative to other categories of loans.
- The cards may be subject to different commissions in case, for example, the customer does not make any consumption during the month.
- If the user does not manage his card (s) carefully, he can accumulate debts that he will never finish paying. Mainly, one must be cautious when buying in installments, that is, when the payment is distributed over several periods. This generates more interest compared to that if the person canceled their consumption in a single payment, for example, for the month.
Credit revolving example
Suppose an individual receives a card with a credit line of $ 2,600 that is revolving every thirty days. Its annual equivalent rate (APR) is 30%.
If the user makes a consumption of US $ 1,600 in April, how much will he have to pay the bank for that month?
First, we remember the formula to obtain the monthly effective rate (TEM):
So, with the example data, the TEM would be:
TEM = ((1 + 0.3) ^ (1/12) -1) = 2.21%
Likewise, interest would be calculated on the amount used:
1,600 * 2.21% = US $ 35.37
Therefore, the debtor will have to return, for example, no later than the fortnight of May, the capital borrowed from the previous month plus interest:
1,600 + 35.37 = US $ 1,635.37