It’s almost impossible to live in the modern world and not have some sort of credit. Whether it’s for a large purchase or just in order to organize day-to-day expenses, we’ve all encountered either revolving or installment credit — or, more likely, both. Since they’re both tracked by credit bureaus, they can have a huge impact on your credit score. But what’s the difference between the two? Today we’ll be talking about revolving credit vs installment credit.
Credit reports will have a variety of details about your credit accounts and will include information for revolving credit and installment credit. While both types of credit are essential for a healthy credit score, they can also harm it. Understanding the differences between the two credits will help you manage your finances effectively.
What Is Revolving Credit?
Credit cards are the most common and well-known form of revolving credit. You’re essentially given a credit limit, and you can spend any amount up to the maximum. Most revolving debt is given as lines of credit where you can make purchases with the account, pay it off, and then continue to buy with the credit available. You can pay down the account repeatedly as long as it remains open. Revolving credit examples include:
- Home equity lines of credit
- Personal lines of credit
- Business line of credit
Another example of revolving credit is the home equity line of credit.
The advantage of revolving credit is that the amount you spend on the credit you’re given is up to you. Additionally, there are no set monthly repayment plans.
With revolving credit, you can choose to pay the amount off in full, or you can pay the minimum amount back and carry your balance over to the next month. However, carrying your balance over to the next month may increase your interest.
Interest rates on credit cards can be high. The average APR (Annual Percentage Rate) in 2020 was over 14.58%. The longer you take to pay off your balance, the more interest you’ll accrue. That’s why it’s advised to pay off the total revolving credit to avoid paying more money on interest.
What Is Installment Credit?
Installment credit involves borrowing a fixed amount in a lump sum and then repaying it in predetermined installments. Additionally, installment credit has a set end date that usually can’t be extended. This type of credit doesn’t allow you to keep borrowing money as you pay off the balance. Examples of installment loans include:
Furthermore, installment credit can be secured or unsecured. Auto or mortgage loans are examples of secured loans, while personal or student loans are commonly unsecured. The interest rates on unsecured loans are typically higher compared to secured credit, but you don’t risk the collateral if you default on it.
An installment credit agreement will include an amortization plan. This means that the principal is reduced slowly over the course of several years when making consistent payments towards the loan. The different types of installment loans will need an additional credit application if you want to borrow more money on the same loan.
Revolving Credit vs Installment Credit
We’ve provided a detailed table below to make it easier for you to see the differences between revolving credit vs installment credit.
|Revolving Credit||Installment Credit|
|Isn’t issued in a predetermined amount||The amount is given in one lump sum|
|Has higher interest rates||Lower interest rates, especially for secured loans|
|You’ll only owe interest on the amount you draw||Fixed interest over a set period of time|
|The credit given can be spent at any time||The lump sum is usually spent in one go on a large purchase such as a house or car|
|The monthly balance can be paid off in full or partially||The loan is paid off in set amounts every month|
|Unpredictable payments because of fluctuating interest rates based on your payment methods||Predictable payment and easy to budget for|
|Easier to be approved for||Can be more difficult to qualify for|
Credit Score Impact
Both revolving and installment credit can affect your credit score. A healthy credit score requires different types of installment loans and/or revolving credit. This can include small business loans and revolving credit cards. Having both types of credit on your report shows creditors that you are responsible enough to successfully manage multiple lines of credit.
However, the one factor that will negatively impact your credit score is not making payments on time or failing to pay your accounts. In this section, we’ll explain how revolving and installment credit affect your FICO score.
How revolving credit affects your credit score
With revolving credit, you decide how much you want to borrow and the amount you want to pay back. However, there is a set minimum that you must pay back. Like we said in the examples of revolving credit above, credit cards and home equity lines of credit function this way.
Ensure that you have a positive payment history by making repayments on time because late repayments on revolving credit can decrease your credit score. What’s more, a significant portion of your FICO score comes from your credit card balance. Lenders will look at your revolving credit utilization to check how much you owe compared to the credit you have available on your card.
Most credit scoring models will reward you for only spending a small portion of your credit.
How installment loans affect your credit score
In order to get an installment loan, you need to first build your credit with revolving credit cards or accounts. On the other hand, installment credit is more straightforward, so it’s easier to maintain your FICO score with this type of credit.
Installment loans can greatly improve your credit score by including on-time payment history in your report. Credit mix is another factor that is used to determine your credit score. If you only had credit cards on your report in the past, an installment loan can help diversify your types of credit.
Furthermore, you can take out an installment loan to pay off your revolving credit to lower your revolving utilization ratio.
Pros and Cons of Installment Loans vs Revolving Credit
Both installment and revolving credit have their own sets of pros and cons. Let’s take a look at them in this next section.
Installment loan pros
One of the biggest advantages of installment loans is their predictability. They have fixed interest rates and monthly repayment plans that are clearly set out. This makes it easier to budget for them and plan other expenses accordingly.
Installment credit can also be extended over several years. A mortgage is a common installment loan example, and it can easily span decades, thus allowing lower monthly installments.
What’s more, if you have a good credit score, lenders will offer you lower interest rates on the loan.
Installment loan cons
The drawback to an installment loan is that it’s difficult to qualify for one, especially if you have a low credit score. You may not qualify for installment credit if you have outstanding debt, a high revolving utilization ratio, or insufficient income.
Some borrowers will also take out installment loans to pay off revolving credit, which can help if you’re struggling financially, but it’s not always ideal. You’ll still need to commit to fixed repayments until your installment loan is paid in full. This may put a strain on you financially, especially if you continue to spend on the credit cards you’ve paid off using your installment loan.
Revolving credit pros
If you make repayments on time and you have a reasonable revolving credit utilization ratio, you’ll improve your credit score steadily over time. The different types of revolving credit can help you if you need a financial boost.
Credit cards allow you to buy the items you may need, such as laptops for school or groceries if you’re running low on cash. For larger amounts, you can use a home equity line of credit to finance home renovations, college tuition, and even pay for medical bills. It’s far easier to get approved for revolving credit than it is for installment loans.
Revolving credit cons
A major disadvantage to revolving credit is the high interest rate. The higher the interest rate means it’s easy to get overwhelmed if you only make minimum payments but borrow high amounts.
Revolving credit, by definition, has variable payments each month. It changes based on the amount borrowed, and it can be difficult to keep track of the amount owed and budget accordingly each month.
There is a lot to consider with installment vs revolving credit, but it will depend on how big of a purchase you want to make and your willingness to commit to repayments. Revolving credit is easier and quicker to pay off, while installment loans usually require several years (or even decades) of repayments.
If you do want to make larger purchases with revolving credit, you can consider a home equity line of credit, but you may experience higher interest rates. If you want to avoid high interest, you can take out an installment loan.
Picking installment loans vs revolving credit will depend on your financial needs, how much you can pay off each month, and your commitment to paying off your installment or revolving debt.
This depends on the type of loan you pay off. A factor that can hurt your score after an early payment is if the loan was your only installment account. You may lose some credit score if you no longer have a good revolving credit vs installment credit mix.
Your revolving utilization or credit utilization ratio compares your credit debt to your credit limit. To maintain a healthy credit, your utilization rate must be low. You should not exceed 30% of your credit utilization rate.
A personal loan falls under installment credit because the amount borrowed is paid to you in a lump sum, and it has fixed monthly repayments.
A payday loan is an installment loan and not a revolving line. It works similar to any type of installment credit where you’re paid a lump sum, and you have to pay the amount back by a specific due date. A payday loan is a short-term loan that is paid off when you get your next paycheck.
Yes, credit cards are the prime example of revolving credit. You get to spend the credit that’s given to you and then pay the balance that’s charged each month. When you make repayments, you’ll have additional credit to spend. With a credit card, you can make small purchases or spend all of your credit at once.
Yes, a mortgage is an installment loan because it has fixed monthly payments and interest rates. You get a large lump sum of money that is used to purchase property, and then you pay off the loan over several years with no recurring credit.
No, having both revolving and installment debt won’t lower your credit score as long as you make repayments on time. Having a combination of credit accounts can improve your credit score because it shows that you’re able to handle your finances more effectively.
Paying off revolving credit vs installment credit will depend on your financial stability. It’s better to pay off revolving debt because you’re not committed to several months or years of repayments. You can pay off revolving debt a lot quicker if you don’t spend money on your credit cards. On the other hand, installment debt has lower interest rates and fixed monthly payments so it can be easier to pay them off over a long period of time.