What Is a Revolving Balance and How Does It Work?
Explore the revolving balance: how this flexible credit line works, its nature, and what it means for your money.
A revolving balance represents a portion of a credit line that remains unpaid after a billing cycle, carrying over to the next period. This concept allows for continuous borrowing, repayment, and re-borrowing up to a specified credit limit.
Understanding Revolving Balance
A revolving balance is the outstanding debt on a credit account that permits repeated borrowing up to a predetermined limit. This balance refers to the amount that was not fully paid off by the due date, transferring to the subsequent cycle. A key characteristic of this type of balance is its flexible nature, meaning the amount owed can fluctuate based on new charges and payments. Borrowers can continuously access funds up to their credit limit, repay portions, and then reuse that available credit without a fixed end date for the credit line itself, provided minimum payments are consistently made.
How Revolving Credit Works
The mechanics of a revolving balance are most commonly observed with credit cards. When purchases are made, they reduce the available credit limit. At the end of a billing period, a statement is issued, detailing the total amount due and a minimum payment requirement. If the full outstanding balance is not paid by the due date, the remaining unpaid amount becomes the revolving balance, accruing interest as it carries over to the next cycle.
Other forms of revolving credit, such as personal lines of credit or home equity lines of credit (HELOCs), function similarly. These credit types provide flexibility, allowing individuals to borrow, repay, and re-borrow funds as needed, unlike installment loans which have a fixed repayment schedule and close once paid off.
Interest Charges on Revolving Balances
Interest typically begins to accrue on a revolving balance from the date transactions are posted, unless a grace period applies from paying the previous balance in full. The Annual Percentage Rate (APR) determines the cost of borrowing, which is then converted into daily or monthly interest charges. Most lenders calculate interest using the average daily balance method. This method involves averaging the balance for each day of the billing cycle, and then applying the daily periodic rate to this average to determine the total interest owed.
If the entire balance is not paid by the due date, interest applies to the full outstanding revolving balance, including any new purchases made during the current billing cycle. This means even new transactions can incur interest from day one if a balance is carried over. Paying the statement balance in full each month is the primary way to avoid interest charges on new purchases.
Implications for Your Financial Health
The presence and management of a revolving balance significantly influence an individual’s financial standing, particularly their credit score. A key metric is the credit utilization ratio, which compares the total revolving balance to the total available credit. A lower utilization ratio, ideally below 30%, indicates responsible credit management and can positively impact credit scores.
A high revolving balance signals increased financial risk to lenders, which can result in a lower credit score and affect eligibility or terms for future loans. Consistently carrying a high revolving balance can lead to a cycle of debt, where minimum payments primarily cover accruing interest rather than reducing the principal. This makes paying down the debt challenging.