Finance 101
Installment Loans vs Revolving Credit: What You Need To Know
There are many reasons you might need a little extra money. Maybe your car won't start. Or your kids' daycare increased prices just before your mortgage was due. There are moving fees to contend with. Fridges just stop working for no good reason and roofs leak no matter how many times you beg them not to.
For all these reasons and more, you might need a loan to help cover these unexpected costs. Two common ways to borrow funds include installment loans and revolving credit.
Installment loans and revolving credit are both types of credit, meaning that you're borrowing money from a financial institution or lender. When borrowing the money, you agree to pay it back according to the terms. For installment loans, you agree to borrow a set amount of money and to pay it back over an agreed-upon time and at an agreed-upon amount. Revolving credit, on the other hand, offers a set limit as to how much money you have to borrow. You can withdraw (up to that limit) and pay it off and then draw again up to the set limit.
Credit, in general, can be a helpful tool when it comes to financing purchases. Read on to learn more about what is the difference between revolving credit and installment loan.
What is an installment loan?
An installment loan is for a fixed amount and duration which you pay back over time, usually in monthly payments. Installment loans can come in higher loan amounts, have longer terms, and provide the total loan amount up front.
One big point to consider with installment loan vs revolving credit is that installment loans have a set end date. When the loan is paid off, the installment loan closes too. Once closed, a borrower will have to reapply if they want another installment loan.
Types of Installment Loans
Installment loans come in several forms.
- Mortgages — Mortgages are a type of loan that allows you to purchase a home. When you get a mortgage, you agree to pay it back in installments (usually over the course of 15 to 30 years) at an agreed-upon interest rate. This is a secure types of loan and is protected by collateral.
- Personal loans — Personal loans are loans you take out to pay for things like emergencies, consolidating debt, and the like. Personal loans are paid back in installments at agreed-upon interest rates over a period that can range from 12 to 96 months.
- Car loans — Car loans are loans you get when purchasing a car. You'll repay this type of installment loan over a period of 12 to 96 months, or according to the terms your lender lays out. Like mortgages, auto loans are a secure type of loan and are protected by collateral.
What is revolving credit?
When discussing revolving credit vs installment loans, it's important to remember how a revolving line of credit is differentiated. A line of revolving credit is provided by a lender and has a set limit you can draw from. Once you draw and spend what you need, you pay your minimum amount due or you can pay another amount. Payments are applied to your outstanding balance. You can then redraw up to your set limit.
Your agreement states you can borrow up to a certain amount, and you will have to make minimum payments based on your periodic billing cycle set by the lender. When any balance "revolves" to the next billing cycle, interest or charges may be added. It is important to read your revolving line of credit agreement that details how any repayment terms and charges.
Types of Revolving Credit
You might be wondering, what is revolving credit? Well, there are actually a few different kinds:
Credit cards — Credit cards can come from a bank, a retail store, or another lender. When you apply for a credit card, you receive a line of credit (or maximum) amount you can spend using a card. You can use up to that amount and pay it off and use it again and again as often as you like.
- Personal line of credit — Personal lines of credit are a type of revolving credit in which you have the ability to access a balance of funds which is disbursed into an existing account accessible to you, such as a checking account. This type of credit is usually a loan that's unsecured, meaning you don't have to have collateral to qualify (like a house or car).
- Home equity loan — A home equity loan is a line of credit you can take out against your house equity. (Equity is the difference between what you still owe on your mortgage and what your home is worth.)
What are some differences between installment loans and revolving credit?
The main difference between revolving and installment credit is that installment loans are given as a lump amount of money upfront that you are required to pay back in agreed-upon installments. Revolving credit is different in that you are given a set amount of money that you can use as much or as little of as you like. To repay money you used from a revolving line of credit, you can pay it back right away or at a later date.
For example, when you purchase a house, you'll most likely get a mortgage loan from a lender to pay for the house. You'll repay the loan in installments every month (with interest). This is a type of installment loan.
FAQs: Installment vs. Revolving Credit
How does revolving credit impact your credit score?
Whether or not revolving credit may impact your credit score depends on how you pay off your balance. If you pay the bill in full each month, your credit score could potentially improve. However, if you spend up to your maximum and don't pay on time, your credit score may go down. Creditors typically report revolving lines of credit to credit reporting agencies. Many factors go into determining and impacting your credit score. Take a moment and learn how to improve your credit score.
How does installment credit impact your credit score?
Installment loans may possibly help improve your credit score (so long as you make your payments on time) because they add a punctual payment history to your credit report. Installment loans also broaden your credit mix, which is one of the factors considered when tabulating your credit score. Using installment loans to build credit? It’s a possibility! Similarly to revolving credit, creditors typically report installment loans to credit reporting agencies. Many factors are involved in the process.
Should you prioritize paying off revolving or installment credit?
When trying to determine which to pay off first — installment loans vs revolving credit — consider which of the loans costs you more money overall. If you can pay them both off at the same time, that would be the best-case scenario. If you have to choose one to pay off first, choose the one that's tied to an asset, like a car or house. You don't want your house to be foreclosed upon or your car to be repossessed. You should review the revolving and installment credit that you may have to determine the best way to prioritize payments.
If you need help allocating money to each loan every month, consider applying a budget to your finances. Don’t delay and learn more about installment loans and how they can help you get your finances back in order today!
When you get a credit card from a retail store, you are getting a revolving line of credit. There is a maximum amount you can spend, but once you pay it back, you can spend this line of credit over and over again.
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