Cash 1 Blog
Revolving Credit vs. Installment Credit: What’s the Difference?
When you have a line of credit, there are two types of repayment structure: revolving credit and installment credit. Both forms of credit are secured or unsecured. A secured installment loan is more common.
Revolving Credit: Your lender advances a set credit limit that you use all at once or in part. You borrow the money, spend it, repay it, and spend it again with revolving credit.
Installment Credit: Your lender advances the total amount, and you repay it with scheduled, periodic payments. You gradually reduce the principal, which leads to paying off the original amount.
What Is Revolving Credit?
A line of credit (LOC) or credit card is the most common revolving credit form. When you make payments on this credit line, your credit limit does not change. You can borrow from it as much as you want if you do not exceed the original limit. There isn't a set payment plan because you are not borrowing a lump sum. You can borrow up to your credit limit. You'll pay more for this flexibility, higher interest rates, and possibly a lower borrowing amount. You'll only be charged for the amount you withdraw every month, not the entire credit limit.
What Is Installment Credit?
A car loan or mortgage is the most common form of this type. Installment credit is an account with a predetermined length, and closing date, often called the loan term. You know the amount of your monthly payments and how long you need to make those payments. If you need to borrow more money, you'll fill out another application.
Examples of Revolving Credit and Installment Credit
Advantages of Revolving Credit
A revolving line of credit has pros and cons that need to be considered. Here's how it stacks up against installment credit.
You get the maximum amount available whenever you need it. Even if you don't need it right now, you'll have a piece of mind. There's no need to go through a lengthy approval process if you need extra cash. You use what you need at the time.
Covers Financial Rough Spots
Even if you have a good credit score, your cash flow can be uneven. Suppose you are a salesperson who sells cars and only makes money from a handful of sales a year. A line of credit will help you keep current on your financial obligations during the months when your cash flow is low.
You also might make most of your money during the last fiscal quarter if you own a seasonal business. Your revolving credit line will allow you to hire needed staff, knowing that you'll meet the added costs later.
Secure Financing Option
If you need a lower interest rate, you could apply for a secured line of credit option. You can use types of collateral to secure your revolving credit. Here are some examples:
- Real estate
- Stock portfolio
- Other valuable assets
You'll have the flexibility to decide how and when your credit line is repaid. Citing the example of the seasonal business, after your busy season, you have plenty of cash on hand. You can postpone repayment until your cash flow supports it.
Disadvantages of Revolving Line of Credit
Higher Interest Rates
Because revolving lines of credit are flexible, lenders consider them to carry more risk. Because of this, you'll likely encounter higher interest rates than installment credit. If you're looking to make a large purchase, consider an installment loan instead.
Americans overspend when they have revolving credit. Check out these credit card debt stats. There is also a tendency to pay the minimum amount every month because it is so small, spending a considerable amount on interest over time.
Lower Credit Limits
As mentioned above, revolving credit is considered higher risk leading lenders to approve you for lower credit limits. If you need substantial financing, this line of credit option is not for you.
Unexpected Adjustable Terms
Advantages of Installment Credit
Installment credit has pros and cons that you need to consider. Here's how it stacks up against a revolving line of credit.
Monthly payments set at the same amount provide predictability for your budget. Compared to revolving credit, Installment credit has a fixed term, interest rate, and in most cases, the same monthly payment.
Larger Loan Limits
Because lenders consider this type of credit less risky, you'll be able to access higher loan limits than with revolving credit if you can meet the requirements. Of course, it doesn't mean that you won't be able to apply for a smaller loan amount. You can get a loan for a few thousand dollars if that's all you need.
Lower Borrowing Costs
In terms of interest rates, installment credit can be less expensive. Lenders offer lower interest rates which will cost less over time. Some people use installment credit to pay off their revolving credit when the interest rate is lower.
Make Large Purchases
One of the common features of installment credit is its versatility. Once approved, you can use it to pay for a major purchase, such as a car. You can also use it to purchase a home and pay later in small amounts for 15 to 30 years.
Disadvantages of Installment Credit
Tough To Qualify
Because of the lower interest rates, lenders have more stringent requirements for you to qualify. They will consider your income, credit history, and other outstanding debt. Most revolving credit lines tend to be more lenient in their lending practices, particularly for higher-risk borrowers.
Some lending agreements will not allow you to pay off your credit line early, so you must read the fine print. You can be charged a substantial fee for paying more than the required amount each month or settle the debt entirely.
As mentioned before, you can use installment credit to pay off your revolving credit if you find a lower interest rate. But, you have to commit not to use your revolving credit. Running up new balances and the monthly payments required by your installment credit will put additional pressure on your budget.
Because the terms of your installment credit are determined before you close, you will not be able to renegotiate. The payment schedule, interest rate, and terms are set in stone. If your financial situation changes or your credit improves, you will have to refinance to get a better interest rate.
How Can You Build Credit With Installment and Revolving Credit?
How you use lines of credit can certainly hurt your credit score if it is not used wisely, but it can be great for your score if you manage both your credit mix and your credit utilization. Follow these tips to improve and build your credit fast.
Don't spend it all at once: How you manage your credit balance is a significant portion of your credit score. Your credit utilization ratio, how much you owe compared to your credit balance, is 30% of your FICO score. Keep your ratio below one-third of your limit, and your credit will improve.
Pay bills on time: Make all your monthly payments on time because your payment history is the biggest factor in your credit score. If you miss any payments, your score will reduce significantly.
Use different types of credit: Lenders feel more confident if you show them that you can manage different kinds of credit. Having both installment and revolving credit will benefit your credit score.
Do not open too many accounts at once: Having different credit types is a benefit, but you do not want to open all of them at once. Be careful not to open too many accounts within a few months or even a year. The best strategy is to build credit steadily over time.
Continue using your credit: Your score will increase if you use credit over an extended period.
Make Educated Decisions About Your Credit
Knowing the difference between revolving and installment credit allows you to make better financial decisions. Many borrowing options are available, whether your goal is to save money on interest, get through tough times, build your credit, or pay off your debt. But, before you apply for any credit, keep in mind how it will affect you. Doing so will allow you to manage your finances and set you up for success.
Joseph Priebe takes pride in assisting audiences with his articles to help them make sound financial decisions.
With over ten years of experience writing financial content his goal at CASH 1 has always been creating engaging and easy-to-digest information for anyone searching for immediate or long-term monetary solutions.
When Joseph is not writing about personal finance, you can find him photographing the Southwest United States with his 4x5 Graflex Crown Graphic camera. He is based in Phoenix, Arizona.