Revolving credit and installment loans are both products that are well known within the financial marketplace. There are a few main differences, but revolving credit involves a line of credit that is continually replenished as the amount borrowed is paid down, whereas installment loans consist of fixed monthly payments that are paid down over a set number of months.
The total loan amount in the United states in December 2022, was reported to be an estimated $12 trillion, up from $11.9 trillion in November 2022. Due to this amount being loaned out to individuals, it’s no surprise that there are many options to choose from when it comes to what type of loan an individual uses. There are many examples of loans, such as mortgages, auto loans, or even payday loans, but in this article, we are going to explore just 2; revolving credit and installment loans.
What is revolving credit?
Revolving credit may be a term that many are not familiar with, but in its most basic form, it is essentially a line of credit that continually renews each time part of, or the entirety of the balance is paid off. Credit cards are an example of revolving credit, as once a borrower is approved for a credit card, they are given a credit limit, which can be used over and over again. A financial institution will give a borrower a credit limit in which they can borrow against, each time a purchase is made, your credit will decrease and each time a payment is made back to the credit provider, your credit will increase.
What are some examples of revolving credit?
We have just discussed one of the main examples of revolving credit, which is a credit card, but there are also some other types of revolving credit, which include:
Home equity line of credit – The CFPB defines a home equity line of credit (HELOC) as an “open end line of credit that allows you to borrow repeatedly against your home equity.” A HELOC consists of a draw period, where you can borrow against the line of credit for a fixed number of years, and a repayment period, where after this time, any money that is still borrowed has to be paid back in regular installments, also over a fixed number of years. During the draw period, much like a credit card, you are able to take out funds up to a credit limit, and as the funds get paid back, you are able to take money out again.
Personal line of credit – These are usually offered by credit unions and banks, and typically require you to have a checking account with that same institution. A personal line of credit allows you much like a credit card, to borrow money up to a credit limit, receive a monthly bill and pay at least a minimum amount each month to pay off the debt, and are classed as unsecured loans, as you have no collateral such as your property to back the loan against.
What’s the best way to manage revolving credit?
There are a few ways that you can manage your revolving credit, to make sure that your line of credit does not grow too large, which can affect your credit score if the payments can no longer be made.
Making all your payments regularly can help to manage your revolving credit, and can actually help with your credit score, providing you are able to consistently make all the minimum payments on time. If you can, try to pay more than the minimum amount off each month, as this can help to lower the overall balance quicker.
One more way to manage revolving credit is to spend within your means. Make sure that you always know what the revolving balance is at all times, so you are able to work out what you can afford and are able to budget for the future.
How does an installment loan differ from revolving credit?
An installment loan works slightly differently to a line of revolving credit. With installment loans, a borrower is given a set loan amount and a set term to pay the funds back to the lender. This can typically be as short as 1 month or as long as 60 months. The payments are made based on a payment schedule and missed payments can negatively impact your credit score. Once the loan is paid off in full, you can then take out another loan.
If you have a bad credit score, you are less likely to get approved for a line of credit, but you can get approved for an installment loan. In order to apply for this, you usually need to have a stable income, and can afford the payments each month without too much financial difficulty.
With the way that installment loans work, it means that you have predictable payments, as you have a set monthly repayment amount over a set period of time, which makes it easier to budget. With revolving credit, the more you take out against your line of credit, the more you have to pay back as the minimum amount each month, which can make budgeting more difficult.
There are several loan types outside of installment loans and revolving credit, such as payday loans. Each loan type comes with their pros and cons, it is up to you to make an informed decision as to which one suits your needs best.