How Revolving Credit Works
Revolving credit lets you carry a balance from month to month, paying only a minimum amount regardless of total charges. A $1,000 purchase becomes a $25 monthly payment. The remaining balance accrues interest at 15-25% APR (about 1.25-2% per month).
Why Balances Linger
Each payment is split between interest and principal. On a $1,000 balance at 20% APR with a $25 minimum, about $16.67 goes to interest and only $8.33 reduces the principal. Adding new charges while carrying a balance creates a debt spiral where the balance grows faster than payments can reduce it.
Reverse Compounding
Investment compounding grows your wealth; revolving debt compounding grows your obligations. At 20% APR, unpaid interest is added to the balance, and next month's interest is calculated on the larger amount. This reverse compounding can turn a $1,000 purchase into $1,630 in total payments over 5.5 years of minimum payments. A financial literacy book explains how to avoid and escape debt traps.