Summary of this article
Revolving credit allows repeated borrowing within a pre-approved limit
Credit cards, overdrafts and digital credit lines are common forms
Interest rates and penalties vary widely across revolving facilities
Revolving credit is a type of borrowing where lenders provide a credit limit which can be used, repaid and reused. Unlike term loans which have a fixed repayment schedule and have a declining balance, revolving credit will reset after repayments are made. Borrowers can withdraw funds up to a sanctioned amount, partly or fully, and get the money available for withdrawal again.
Interest is charged only on the amount used and not the entire sanctioned limit. However, revolving credit often has a higher rate of interest as compared to traditional loans due to their flexibility. Fees, penalties, and compounding interest can add up to the overall cost if balances are not paid off for extended periods of time.
Here are the primary types of revolving credit generally available to individual borrowers.
Credit Cards
The most common type of revolving credit comes with credit cards. A card issuer sets a credit limit based on various specific factors, such as income, repayment history and credit score. Cardholders can make purchases, withdraw cash, and pay for the balance either in full or in part.
Most credit cards offer an interest-free period (grace period) of about 20-50 days on purchases provided that the entire amount outstanding is paid by the due date. If only the minimum payment is made, interest is charged on the rest and on any additional purchase as well.
The rate of interest on credit cards is typically between 30 per cent and 48 per cent per annum. Some premium cards charge lower rates and entry level cards will charge slightly higher rates.
Common additional charges are:
Late payment fee is about Rs 100-1,300 depending on the outstanding amount.
Cash withdrawal fee is around 2.50-3 per cent of the amount withdrawn, but minimum fee is often close to Rs 300.
Over limit fees also apply in some cases if one spends more than the approved credit limit.
Interest on cash withdrawals usually starts immediately without any interest free period.
Bank Overdraft Facilities
An overdraft allows accountholders to withdraw more money than the balance available in their bank account. The overdraft limit is agreed upon in advance with the bank and can be linked to salary accounts, savings accounts, or secured assets, such as fixed deposits.
Unlike credit cards, overdrafts are often used for short term liquidity needs, such as managing temporary cash flow gaps. Borrowers only pay interest on the actual amount withdrawn and for the number of days of that amount outstanding.
Interest rates for overdraft facilities vary greatly depending on whether the facility is a secured or unsecured loan. Overdrafts associated with deposits or securities (secured overdrafts) can have rates of interest around 9-18 per cent per annum. Unsecured overdrafts or those tied to salary accounts can be between 10.50 per cent and 40 per cent.
Banks also may charge processing fees for the set-up of the overdraft along with penal interest if the limits are exceeded.
Personal Line Of Credit
A personal line of credit (PLOC) is much like a credit card, but without the actual card to make a transaction with. Lenders grant a credit limit that can be accessed through online transfers, linked debit cards, or using mobile banking.
Borrowers can take out any amount out of the limit and pay it back at their own time with minimum monthly payments. Once repayments are made, the available limit is restored.
Interest rates for personal lines of credit typically range from 9-30 per cent annually depending on the borrower's credit profile and whether the facility is a secured loan. Many competitive, high-credit offers range from 10-15 per cent. Rates vary greatly depending on credit score, with lower rates (8.75-10 per cent) available for excellent credit and riskier profiles potentially exceeding 20-30 per cent.
Some lenders impose a commitment fee if the sanctioned limit remains unused for long periods of time.
There are potential late payment penalties of Rs 300-750 plus additional interest on the amount due.
Buy Now Pay Later Credit Lines
Many digital lenders and payment platforms provide revolving credit in the form of buy now pay later (BNPL). Users are given a small credit limit which they can use multiple times on purchases within partner platforms or through digital wallets.
These facilities often advertise nil interest, if the balance is cleared within a short period of time, usually 15-45 days, and typically in four instalments. However, if payments are made on a delayed or instalment basis, interest charges may be imposed.
The typical interest rates on extended repayments can be anywhere between 10 per cent, and 30 per cent per year. Late payment charges are typically Rs 100-700 for missing out a payment cycle. Some lenders might charge a flat penalty of up to Rs 100 for every day.
Since these credits are generally small, these are mostly used to make everyday purchases rather than large expenses.
Loan Against Securities/Deposit With Revolving Limits
Some lenders offer revolving credit limits against collateral, such as fixed deposits (FDs), shares, mutual funds, or insurance policies. The borrower is allowed to borrow up to a certain percentage of the value of the pledged asset.
Since these facilities are secured, the rate of interest is less than that on the other forms of revolving credit. Rates are often between 8 per cent and 12 per cent annually based upon the kind of collateral and lender policies.
If the value of the pledged securities drops substantially, lenders may demand more collateral or partial repayment to keep the credit limit.
Costs And Risks Of Revolving Credit
Revolving credit has an advantage of flexibility and easy access to funds, thus making it helpful for short-term borrowing needs. However, the convenience comes with a higher cost of borrowing as compared to traditional loans.
The rate of interest on revolving credits are typically higher, late payment fees, processing fees and penal interest may be added on. When borrowers continue to roll over balances, the interest can really add up very quickly due to monthly compounding.
Credit utilisation also has an impact on credit score. Consistently using a substantial portion of available credit limit may lead to a drop in a borrower's credit score, and increase ineligibility for future loans.
Understanding the different types of revolving credit, as well as the costs that come with them, can help borrowers understand when such facilities may be helpful and when other forms of borrowing may be more appropriate.
