Revolving Debt

A revolving debt is a debt which does not have to be amortized within a specific term. It can be drawn on and amortized in full or in part at any time. Interest on revolving debt is charged as a percentage of the existing debt at any point in time.

Unlike amortizing loans, revolving loans do not need to be repaid as long as interest payments are met. Typically, revolving debt instruments have a limit on the total amount of debt which they can generate. This limit is commonly referred to as the credit limit. The amount which can be borrowed using a revolving debt instrument makes up its line of credit.

Instruments which enable revolving debt include credit cards, bank accounts with an overdraft allowance (such as Swiss business current accounts), Lombard loans, non-amortizing mortgages (first mortgage) and brokerage accounts which allow leveraged trading, among others. Perpetual bonds which never mature are another revolving debt instrument. As long as the company or government which issues perpetual bonds meets its interest-payment obligations, it does not have to repay the loan.

Revolving debt may be secured, as is the case with Lombard loans (secured by assets deposited as collateral), non-amortizing mortgages (secured by real estate) and broker leverage (secured by securities held in custody accounts). It may also be unsecured, as is the case with standard credit cards and bank account overdrafts.

Example of revolving debt:

You apply for a credit card with a 12% effective interest rate which is charged on your balance at the end of each month. Because you have good creditworthiness, the card issuer grants you a 5000-franc line of credit. You do not have to borrow the full 5000 francs or even a single franc, but you have the option to borrow it if you choose to.

Suppose you use your credit card to buy a 1500-franc vacation package one month and only make the minimum required payment plus the interest owed at the end of the month. For this example, we will assume the minimum payment is 5% of the balance, or 75 francs. The interest for that month is 15 francs (12% of 1500 divided by 12). You carry over 1425 francs of debt to the next month. The next month, you spend another 2000 francs using your credit card and again you make the minimum payment (100 francs in this case) plus the interest of 34.25 francs. You carry over the remaining 1900 francs of debt, bringing your total credit card debt up to 3325 francs. The next month you have some extra money so you repay 500 francs of your debt, bringing it down to 2825 francs. You also pay the interest of 28.25 francs. Shortly after you change a 1000-franc purchase to your card, pushing your debt back up to 3825 francs.

This could carry on indefinitely, but your debt will never be higher than your credit limit of 5000 francs. As long as you keep paying interest and making the minimum payment you could carry this debt indefinitely.

See: Revolving credit