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FINANCIALLY AESTHETIC · GUIDE 15/37
CREDIT CARD DEBT & REVOLVING BORROWING
FA-3.2 · Debt & Borrowing
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THE COST QUESTION
Revolving debt feels flexible because there's no fixed finish line - which is exactly the danger.
Revolving Credit: Principles and How It Works
A credit card allows you to pay for goods and services in stores, online, and over the phone. Your credit limit is the maximum total amount you can spend. As you repay your balance, you gain access to more credit. This is known as revolving credit.
Revolving credit is a type of consumer credit characterized by a high degree of flexibility in both its use and repayment - but that’s not all. Revolving credit allows the borrower to use a line of credit made available by a bank, a specialized financial institution, or a major retailer.
When you take out a revolving credit line, you have access to a sum of money that you can use as you wish: in one or more installments, either via a dedicated credit card that allows you to pay for purchases or withdraw cash, or by check or bank transfer to your bank account. But be careful - these conveniences come with trade-offs.
Like any loan, you must begin repaying the amount borrowed. From the first time you use the credit, a monthly payment is deducted from your bank account until the credit line is fully replenished. As for the interest rate, it is variable.
Another feature of revolving credit is that a portion of each monthly payment is used to replenish a reserve of available funds that can be used again.
The Cost of Revolving Credit
Revolving credit allows you to adjust your usage and the amounts borrowed as your needs change. And its interest rate is subject to change. Because of these characteristics, it is more difficult to know the exact total cost of the loan, which depends on how you use it.
You do not know the cost of revolving credit at the time you execute the contract. The loan rate is disclosed to you as an APR, but it may be adjusted and therefore vary depending on when you use the revolving credit.
Indeed, and this is one of the risks of revolving credit: you don’t know in advance how much it might cost, and in this case, it can be expensive. Interest rates are high and generally higher than those for traditional forms of consumer credit. Also, the interest rate is adjustable, meaning it can go up or down depending on changes in a reference rate.
The interest rate on a revolving credit line is either fixed or, more commonly, adjustable. When the rate is adjustable, this means that the lender has the right to adjust the rate under the terms set forth in the offer. The rate follows changes - upward or downward - in the reference rate or index.
In any case, the lender granting you the credit is required to notify you of any rate change before the effective date of the change. Within 30 days of receiving this notification, you may reject the rate change by sending a written notice to the lender. This rejection terminates the revolving credit contract. You will no longer be able to “draw” from the credit line. However, you must continue to repay the credit you have already used according to the scheduled repayment plan.
The APR includes the interest rate and all compulsory fees associated with granting the loan: handling charges, and borrower insurance contributions if such insurance is required. It allows you to compare different loan offers. The APR must not exceed the usury rate applicable to the relevant loan category.
The Debt Cycle
Clearly, it can be tempting to borrow money again before you have fully repaid the amount previously borrowed. It is then difficult to break free from this cycle of credit.
This form of financing should remain an exception, and the amounts borrowed should be small - especially for people in a precarious financial situation, for whom it can exacerbate their difficulties.
Be careful not to accumulate multiple revolving lines of credit; you risk falling into over-indebtedness, especially if you take out these loans to repay others. If you wish to take out a loan to finance a specific purchase, try to obtain a secured loan instead: while this type of loan is less flexible and harder to obtain, it is less expensive. Also, if it is a special-purpose loan and you exercise your right of withdrawal, you will not be required to purchase the item. Do not let a revolving credit line continue beyond your need. As soon as you can, make an early repayment (which does not incur a penalty) or increase your monthly payments to accelerate repayment.
Be aware that if a consumer requests in-store credit for a good or service costing more than 1,000 euros, the lender is required to offer the consumer a choice between a revolving credit line and traditional consumer credit.
Carrying Over a Balance and Paying Interest
The money you owe on your credit card is your balance. Try to pay it off each month before the due date. If you don’t pay your balance by the due date, you’ll pay interest starting from the date of purchase. The interest you pay increases the cost of everything you buy with your credit card.
Paying off your balance each month shows lenders that you are a responsible borrower. Making late payments or skipping payments will damage your credit score.
You will pay interest if you do not pay your credit card balance in full by the due date. You will continue to pay interest until your balance is repaid in full.
Interest rates vary depending on the financial institution and the transaction type. For example, you may pay an interest rate of 19% on regular purchases. You may pay an interest rate of 22% on cash advances or transactions such as cash withdrawals. Rates for specialty credit cards and merchant cards may be higher.
Credit card issuers give you a grace period to pay off the previous month’s purchases without interest. The grace period begins on the last day of your billing period. You can find your billing period on your credit card statement. The grace period does not apply to:
- cash advances
- transactions treated as cash transactions
- balance transfers
Federally regulated financial institutions must provide a grace period of at least 21 days.
For example, suppose you buy a smartphone with your credit card on January 15. On February 1, you receive your January credit card statement, which includes the charge for the smartphone. A 21-day interest-free grace period applies to purchases made in January. You have until February 21 to pay for your smartphone and any other purchases to avoid paying interest.
If you do not make the required minimum monthly payments by the due date, your interest rate may increase. Interest rate increases may vary depending on the type of credit card and the card issuer. The increase may be temporary or permanent. If you miss a payment, you could lose your promotional interest rate. Your interest rate may also increase.
The Minimum Payment and Its Effects
Be sure to make at least the minimum payment if you cannot pay off your balance. The minimum payment is the smallest amount you must pay each month toward your credit card balance.
Your minimum payment will be:
- a fixed dollar amount, usually $10, plus interest and fees, or
- the greater of a fixed dollar amount, usually $10, or a percentage of your outstanding balance, usually 3%
Your credit agreement explains how your issuer calculates your minimum payment.
Paying only the minimum amount means that:
- it takes you longer to pay off your balance
- you pay more in interest
Increasing your monthly payments reduces the time it takes to pay off your balance. Even a small amount will significantly reduce the time.
| Payment Scenarios | Starting Balance | Amount of Payment | Interest Rate | Time Required to Pay Off the Balance | Interest Paid | Total Amount Paid |
| Scenario 1: You make only the minimum payment each month | $2,000 | $60 | 18% | 3 years, 11 months | $793 | $2,793 |
| Scenario 2: You make the minimum payment each month, plus $100 | $2,000 | $160 | 18% | 1 year, 2 months | $231 | $2,231 |
Table 1: Costs and Time Required to Pay Off Your Credit Card If You Make Only the Minimum Payment and If You Increase Your Monthly Payments
Your credit card issuer may be a federally regulated financial institution. In that case, your credit card statements must indicate how long it will take to pay off your balance if you make only the minimum payments.
If you do not pay at least the minimum amount, you risk:
- an increase in your interest rate
- damaging your credit score
- losing the benefit of a promotional rate, if you have one
- having your financial institution cancel your credit card
- having your credit card issuer cancel your credit card balance insurance
How Payments Are Applied to Your Balance
Different interest rates apply to different transaction types for credit cards. For example, cash advances often have a higher interest rate than purchases. This means that different rates will apply to your balance depending on how you use your credit card.
As a general rule, your minimum payment is applied to the portion of your balance with the lowest interest rate. Any amount exceeding the minimum payment is applied to your balance in one of the following two ways:
- to the portion of the balance with the highest interest rate
- proportionally to the entire balance
Your credit card issuer may be a federally regulated financial institution. In that case, it can decide how to apply your minimum payment to your balance. Check your credit agreement or ask your card issuer how it applies payments to your balance.
Cash Advances: An Expensive Way to Borrow
You can use a credit card to get a cash advance:
- by withdrawing cash at an ATM
- from a teller at a financial institution
There is no interest-free grace period for cash advances. You begin paying interest from the moment you receive the cash advance until it is repaid in full. The interest rate on cash advances is usually higher than for regular purchases. For example, the interest rate might be 19% for a regular purchase but 22% for a cash advance.
A cash advance can be a very expensive way to borrow money. Before taking out a cash advance, consider a less expensive way to borrow. Consider a personal loan or a line of credit. When you use cash advances, try to repay your balance as quickly as possible.
You may have to pay fees each time you take out a cash advance. The fees may be:
- a fixed amount for each cash advance
- a percentage of the cash advance amount
- a fixed amount plus a percentage of the cash advance amount
Some financial institutions set a minimum and maximum amount for these fees.
Financial institutions often treat the following transaction types as cash advances:
- electronic transfers from one financial institution to another
- money orders (a paper payment method with a prepaid amount)
- Traveler’s checks (prepaid checks that allow you to pay for goods and services while traveling)
- gambling transactions (such as placing bets or purchasing casino tokens or lottery tickets)
As with a cash advance, you must pay interest starting from the date of the transaction. Interest rates for these transactions are usually higher than for regular purchases. You may also have to pay fees each time you make this type of transaction.
Signs of Worsening Debt
If one or more of the following situations apply to you, you may be living beyond your means:
- Your credit card balance keeps going up
- You’re reaching your credit card limit
- You carry over your credit card balance every month
- You make no payments or only the minimum payment on your credit card
- You take cash advances on your credit card
If you often find yourself in one of these situations, do the following:
- Stop using your credit card, if possible
- Avoid applying for additional credit, since you’ve reached your credit limit on other credit cards
- Review your budget to find ways to reduce your expenses
- If you must use credit, consider credit options that cost less
Missing or Making Late Payments
If you don’t pay at least the minimum amount or make a late payment, you risk:
- having your interest rate increase
- damaging your credit score
- losing any promotional rate you may have
- having your financial institution cancel your credit card
Your credit card issuer may offer you a payment holiday. This means they allow you to skip a payment. However, interest continues to accrue.
Your credit card issuer may be a federally regulated financial institution. In that case, it must clearly inform you whether interest is charged to your account when you skip a payment. This information must be included in the payment deferral offer.
Breaking the Cycle: Other Credit Options
If you’re having trouble repaying your credit card, consider other ways to borrow money. Some products may cost you less in interest.
These options may include:
- a low-interest credit card, such as a secured credit card
- a line of credit or a personal loan
Contact your financial institution to discuss the options available to you.
BEFORE YOU SIGN
Stop new charges, understand the minimum-payment math and choose a repayment order you can sustain.
CURRENT-RULES CHECK
Legal protections, tax rates, reporting duties, deadlines and product rules change by country and over time. Use the jurisdiction labels in this guide and check the linked official source before acting.
- Financial Consumer Agency of Canada - How credit cards work - Canada - cards, statements and interest.
- CFPB - Credit-card debt consolidation - United States - consolidation cautions.
