Revolving credit and installment credit are two types of credit that work differently. Revolving credit allows borrowers to spend the borrowed money up to a predetermined credit limit, repay it, and spend it again. With installment credit, the borrower receives a lump sum of money that they must repay, in installments, by a specified date. Both revolving and installment credit come in secured and unsecured forms, but it is more common to see secured installment loans.
- Installment credit provides the borrower with a lump sum of money, which they must repay in fixed installments by a certain date.
- With revolving credit, the borrower is given a credit limit that they can borrow against repeatedly. While they may be required to make minimum monthly payments, it has no fixed end date for repayment in full.
- Credit cards and credit lines are examples of revolving credit.
- Examples of installment loans include mortgages, auto loans, student loans, and personal loans.
What Is Revolving Credit?
Credit cards and a lines of credit (LOC) are two common forms of revolving credit. You can dip into your account to borrow more money as often as you want, as long as you do not exceed your predetermined credit limit.
As you pay money back, you replenish your available credit. For example, suppose you have a credit card with a $10,000 credit limit. If you charge $3,000 worth of items, your available credit on that card is now $7,000. If you repay the $3,000, your credit limit is back to $10,000. This can go on month after month, year after year, for as long as you have that card.
You will owe interest on your outstanding balance but not on the entire credit limit.
Revolving credit can be a more dangerous way to borrow than installment credit. A big part of your credit score (30% in many cases) is your credit utilization ratio—for example, how close your card balance is to your overall limit on each card. Carrying relatively high balances drags down your score.
What Is Installment Credit?
Unlike revolving credit, an installment loan has a predetermined length, often referred to as the loan term. The loan agreement usually includes an amortization schedule, in which the principal is gradually reduced through installment payments over the course of several years. You will receive the money you borrow all at once in a single lump sum.
Common installment loans include mortgages, auto loans, student loans, and personal loans. With each of these, you know how much your monthly payment is and how long you will have to make payments. If you want to borrow more money at any point you'll have to take out another loan.
|Revolving Credit vs. Installment Credit|
|Revolving Credit||Installment Credit|
|Amount loaned can be used at any time, paid back, and borrowed again as needed||Borrowers have access to the amount loaned in one lump sum|
|Often has higher interest rates||Can be tougher to qualify for|
|Borrowers only owe interest on the amount they use||Fixed number of payments, including interest, over a set period of time|
Pros and Cons of Revolving Credit
Revolving credit is flexible. You only borrow as much as you need, when you need it. Also, because you can keep borrowing again and again as long as you don't exceed your credit limit, you don't have to go through a new loan application process every time you need money. Having access to revolving credit can also be useful in an emergency when you have to get your hands on cash quickly.
The major downside of revolving credit is that it is easy to get in trouble with if you aren't careful and run up a big balance. Revolving credit, particularly credit cards, can also have very high interest rates, which only compounds the problem.
Pros and Cons of Installment Credit
The greatest benefit of installment credit is its predictability. You'll have a set repayment schedule that you can budget for each month until the loan is completely paid off. In addition, installment loans often charge lower interest rates than revolving credit. For example, at this writing, the average credit card interest rate is 23.24%, while the average 30-year fixed-rate mortgage is charging 6.60%. For that reason, people sometimes take out installment loans (such as a home equity loan) to pay off their revolving credit balances.
On the downside, installment credit lenders tend to have more stringent qualification requirements regarding your income, your other outstanding debts, and your credit history. Most credit card issuers are more lenient in their lending practices, particularly for higher-risk borrowers. Plus, as mentioned earlier, each time you need installment credit you'll have to go through the application process again. That is not only time-consuming, but if your credit score has taken a hit since you last applied, you may not even qualify for a loan.
What Is a Revolving Loan Facility?
A revolving loan facility is a form of revolving credit typically made available to businesses. It works much the same as revolving credit for an individual consumer, although it usually involves a larger amount of money.
What Is the Difference Between a Secured Loan and an Unsecured Loan?
In a secured loan, the borrower puts up some form of collateral. With a home mortgage, for example, the home typically serves as collateral. In an unsecured loan, the lender makes the loan on the basis of the borrower's creditworthiness. Because secured loans are less risky for lenders they usually charge lower interest rates on them than on unsecured loans.
Are Credit Cards Secured or Unsecured?
Conventional credit cards are unsecured. However there is a special type of credit card called a secured credit card. With a secured card, the borrower puts some money into an account with the card issuer, which serves as collateral and also as the card's credit limit. Secured cards are an option for people with a poor credit record or no credit history. Once the person has demonstrated that they have handled their secured card responsibly, they may become eligible for a regular card.
The Bottom Line
Revolving credit and installment credit can both be useful when you need to borrow money. The key is to choose the type that meets your needs at any given time—and not to let either of them lull you into taking on more debt than you can comfortably manage.
Experian. "What is a Credit Utilization Ratio?"
Consumer Financial Protection Bureau. "Building Credit From Scratch."