What you should know

• Revolving credit is a type of credit line you can draw from when necessary. You have the ability to borrow money on your terms.
• With an installment credit account, you borrow a predetermined amount of money from a lender and pay it back in scheduled, fixed payments.
• Whether you choose an installment or revolving account, the important thing is to borrow responsibly and keep up on your payments.
• Some examples of installment credit would be mortgages, auto, student, and personal loans.
• Some examples of revolving credit would be credit cards and lines of credit.

When it comes to your finances, you should understand the difference between two common types of credit: revolving credit and installment credit.

Revolving Credit: Your lender will advance you a credit limit, and you may use the limit in full or in part. You can borrow, spend, repay the borrowed amount, and then spend again on revolving credit.

Installment Credit: With this type of credit, you borrow the total amount upfront and repay the lender through scheduled, periodic payments that include both principal, interest, and any fees. As you make payments, you gradually reduce the original amount you borrowed, until the loan is fully paid off..

What Is Revolving Credit?

Revolving credit, like a line of credit (LOC) or credit card, is the most common type of credit. When you open a revolving credit account you will be assigned a credit limit. This is the maximum amount that you can spend at any time. At the end of each month, you will receive a statement with your current balance. That is the amount owed. To keep your credit account on track, you should make the minimum payment, at least, every month.

After that, you have the ability to either carry over the remaining balance into the next month or pay it off in full to avoid additional interest. If you decide to only make the minimum payment, keep in mind that the remaining balance may be accruing additional interest. You will be responsible for paying down the existing balance and that extra interest.

Discover more: What Is Revolving Credit & How Does It Work?

Examples of Revolving Credit

Revolving credit provides borrowers with flexibility and convenience. Each option offers unique benefits catered to different financial needs, but all share the characteristic of continuous access to credit.

Credit Cards

A credit card is likely the most common type of revolving credit and the easiest to understand. You can make purchases with your card up to the credit limit, pay it off, and then repeat the process. Credit cards are a convenient buying option, safer than carrying large amounts of cash, and often come with rewards.

Personal Line of Credit

A personal line of credit functions like an open loan, in which you are assigned a total limit. You can take money from your line of credit whenever you need it, and you only pay interest on the money you use.

Business Line of Credit

Business owners may access a line of credit to manage cash flow, cover expenses, or take advantage of opportunities for their business. In practice, personal lines of credit and business lines of credit function similarly; they are like a personal line of credit, but the credit must be used for business expenses.

What is Installment Credit?

When you think about installment credit, car loans and mortgages probably come to mind first. With this type of loan, there’s a set timeline and end date, so you know exactly what your monthly payments will be and how long you'll be making them. If you find yourself needing more funds, you'll need to fill out a new application to borrow again.

Discover more: What Is Installment Credit?

Examples of Installment Credit

Installment credit typically has a fixed rate and clear terms that help you manage your budget. Here are some examples of installment credit.

Personal Loans

Personal installment loans allow you to use the money as you see fit. If you want to consolidate debt, perform repairs on your home or car, or receive funding for unexpected expenses then a personal installment loan is a good fit.

Student Loans

Student loans are unsecured loans specifically created to help you pay for your education. In many cases, repayment of the loans is deferred until after graduation.

Mortgages

Mortgages are secured loans that are used to purchase a home. These come in many forms and are typically repaid over 15 to 30 years, which gives you plenty of time to pay off your home.

Key Differences Between Revolving Credit and Installment Credit

Credit Purpose

Revolving Credit: Best suited for recurring expenses or short-term borrowing needs. Installment Credit: Most suitable for large and planned purchases such as homes or vehicles.

Borrowing

Revolving Credit: It has a set credit limit that you borrow from, repay, and borrow from again, as long as you stay within that limit.

Installment Credit: It has a fixed loan amount disbursed in a lump sum.

Interest Rates

Revolving Credit: You have variable rates that could change over time.

Installment Credit: Lenders typically offer fixed rates and only charge you interest on the outstanding principal.

Repayment

Revolving Credit: You are offered a repayment plan that gives flexibility by either paying the balance off, or making minimum payments each month.

Installment Credit: You have fixed payments each month.

Cost

Revolving Credit: It’s easy for you to get into a situation that can be expensive, if you aren't focused on the outstanding balance.

Installment Credit: You are provided predictable total costs because of fixed rates and terms.

Pros and Cons of Revolving Credit

Revolving credit lets you borrow money, pay it back, and then borrow again, up to a specific limit. This can help you handle short-term costs, manage your money, and steady your cash flow. However, there are both good and bad sides to using it.

Pros

Flexibility and Convenience

A line of credit offers flexible financing, allowing you to borrow and repay as needed, giving you a financial safety net.

Availability of Funds

A key perk of a revolving line of credit is having funds ready when needed. This can be handy for unexpected expenses or seizing opportunities as they arise.

Potential for Credit Building

Your credit score may improve when you use revolving credit wisely, such as making on-time payments and maintaining a low debt-to-income ratio.

Discover more: What Is Debt-To-Income Ratio?

Cons

Higher Interest Rates

Revolving credit accounts, like credit cards, may have higher Annual Percentage Rates (APR’s), fees, or late payment fees.

Risk of Overspending

Easy access to credit may also cause you to overspend and create financial difficulties.

Impact on Credit Score

If you don't manage your monthly payments, you may default on the loan, which may negatively impact your credit score.

Pros and Cons of Installment Credit

If you're considering installment credit to help your finances, you may want to weigh its advantages and disadvantages.

Pros

Flexible Repayment Terms

Installment loans feature different repayment terms: mortgages (10-30 years), car loans (36-72 months), and personal loans (2-5 years). Shorter terms usually mean less interest but higher monthly payments, while longer terms have lower payments but likely a higher cost in total interest.

Lower Interest Rates

Installment credit typically offers lower interest rates compared to credit cards.

Credit Building Opportunities

Making on-time payments and keeping a low balance on your credit line may lead to better credit scores.

Discover more: Follow This Advice To Improve Your Credit Score Fast

Cons

Potential Fees

Installment loans may have extra fees, such as application, origination, late charges, or a prepayment penalty for early repayment. Mortgages typically include additional closing costs.

Impact on Credit Score

Making a late payment on your installment loan or missing payments may damage your credit rating.

Risk of Overextension

Taking on more debt than you can repay leads to financial strain and potential default.

The Final Word

Both revolving credit and installment credit can be helpful when you need to borrow some money. The trick is to select the one that suits your needs at the moment, while being mindful not to let either lead you into taking on more debt than you can comfortably handle.