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Last updated: Apr 21st, 2011

Revolving Debt:

Revolving debt is debt where interest is charged not only on principal (the original money loaned) but on the interest itself.

I do not like the idea of revolving debt and would support a complete ban on revolving debt. Why? I think that revolving debt sets up the wrong incentives. The basic idea of interest is that interest is a fee charged for the use of money. The borrower uses the lender's money in exchange for this fee. The charging of additional interest on accumulated interest is allowing the lender to earn additional money on money that was not theirs to begin with. This extra charge is beneficial to the lender but not the borrower for two reasons:

Revolving debt opens up the potential for a massive wealth transfer from borrower to lender. The greatest gains for the lender are in the situations where the borrower is struggling to pay off the loan and perhaps misses some payments early in the loan's lifetime, but eventually is able to pay the whole loan off or at least continue paying on it for a long time before defaulting. Lenders have the balance of power on their side to begin with, as they have the money, experience, and typically a team of analysts and legal experts. The lender not only determines the terms of the loan, but has better information and knowledge about the risks and impacts of the loan. The borrower usually only has the choice of accepting or declining the loan, and often does not have much information or experience about the true implications of taking out the loan.

Arguments in support of revolving debt:

Lenders who support revolving debt make the argument in support of this practice, that revolving debt allows them to charge lower interest rates for high-risk loans. They argue that revolving debt also makes loans available for people for whom loans would not otherwise be available.

I think that these arguments are not valid. To a lender, the purpose of lending is to earn money. But in the context of society as a whole, the purpose is to invest money into productive activities, putting money to use for good purposes.

The impact of a ban on revolving debt:

I have several predictions about the effects that a ban on revolving debt would have for society:

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