Revolving Credit vs Installment Credit
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Credit cards and other revolving credit accounts function in a cyclical way. The consumer initiates the borrowing cycle by making a purchase and then repaying the balance over one or more months.
Car loans and other installment credit accounts involve borrowing a lump sum and repaying the balance over a predefined series of months.
What is Revolving Credit?
Two of the most common types of revolving credit accounts include credit cards and home equity lines of credit (HELOCs). Revolving credit accounts typically have an established maximum or limit, which could change at some point.
The account holder may make purchases that accrue debt often–assuming they remain within their credit limit. Revolving debt accounts lack a fixed or formalized repayment plan; however, a required minimum payment often applies each month when a balance remains.
The interest rates that lenders impose on revolving debt are typically defined in the agreement terms when initiating the account. Those with a positive credit history and good credit score are most likely to qualify for the most desirable credit card accounts with lower interest rates.
Any remaining debt (balance) on a revolving account at the end of the billing cycle will typically incur the finance charges associated with the interest rate.
Many consumers obtain credit cards or revolving credit lines to temporarily cover unforeseen expenses that arise such as car repairs or medical treatment. Some retailers offer credit cards to customers specifically for purchasing their goods or services.
What is Installment Credit?
The most common types of installment debt accounts include home mortgages, auto loans, student loans, and personal loans. Installment loans often finance large purchases and have lengthy, multi-year repayment schedules.
Installment loans feature a prearranged length of time for repayment (loan term) and a set monthly payment. Although often classified as personal (installment) loans, many “payday” loans today also have characteristics traditionally associated with revolving accounts.
Installment loans typically have a defined amortization schedule, which illustrates how each monthly payment is applied to the amount borrowed (the principal) and the interest until the loan is fully repaid.
Examples of Installment Loans
| Loan Type | Debt Amount | Interest Rate | Term (Months) | Monthly Payment | Total Interest |
| Mortgage A | $ 300,000 | 5.5 % | 360 (30 year) | $1,703 | $313,212 |
| Mortgage B | $ 400,000 | 6.0 % | 360 (30 year) | $2,398 | $463,353 |
| Car Loan A | $ 15,000 | 5.0 % | 48 | $345 | $1,581 |
| Car Loan B | $ 20,000 | 6.0 % | 60 | $387 | $3,199 |
Source: Installment Loan Calculator
An installment loan is essentially a one-time agreement that has a closed-end date.
The Difference Between the Two
Both secured and unsecured debts exist in the installment and revolving loan markets. A secured debt involves some property or asset that serves as collateral.
Unlike most unsecured debts such as credit cards or personal loans, the lender in a secured loan may assume control or repossess types of collateral if a borrower fails in fulfilling their repayment obligation; therefore, car loans and mortgage loans represent common secured debts.
Difference 1: Installment Loans Have End Dates
Unlike a revolving credit account, an installment loan has a predetermined end date. After a borrower makes the monthly payments for the full term, the loan agreement terminates and the account status on your credit report shifts from active to “closed” or “inactive” or “paid as agreed.”
A revolving credit account will generally remain open or active unless the borrower specifically closes the card or line of credit.
Difference 2: How Much You Pay
Both of these accounts have minimum payments that must be paid. But they’re calculated in a different way.
An installment loan has a fixed, monthly payment that the borrower must make. It is the same amount every month.
A revolving account, such as a credit card, typically allows the borrower much more flexibility.
For example, your monthly credit card statement usually lists the total balance owed, which the borrower may opt for paying off in full; however, the account holder might also choose the option of making only a partial, nominal minimum payment.
As your revolving account balance changes over time, so too will your minimum payment.
Keep in mind that differing your payments will result in accruing potentially substantial interest charges.
Remember that most lenders will report a single late or partial payment to the credit bureaus, which results in an adverse credit report entry that will negatively impact your credit score.
Difference 3: Lump Sum Debt vs. Changes Over Time
When a borrower enters an installment loan agreement, they will incur a “lump sum” amount of debt. This occurs because the borrower typically enters the loan agreement specifically for financing a large purchase such as a home or car.
A consumer who opens a credit card agreement or another revolving credit account is not automatically assuming a debt. Unlike an installment loan account, revolving credit accounts generally finance smaller, ongoing individual purchases.
For example, you could charge $100 on a credit card or $1,000. The level of debt goes up and down over time in a revolving credit account.
Pros and Cons of Installment Credit
Pros
Installment loans may make big-ticket items more affordable using longer, multi-year repayment terms. This set monthly payment schedule is also predictable, which fits well when creating a written budget, and has a clear, definite end date.
In many cases, installment credit options offer attractive interest rates; therefore, consumers often will consolidate various higher-interest revolving accounts into a single installment loan when implementing a debt management strategy.
Cons
The loan funds in most installment credit options provide financing for a single, one-time purchase in the form of a lump sum. Borrowers seeking additional financing through these sources must typically enter the formal credit application process again.
Some lenders that issue installment credit products allow no options for prepaying a loan; in fact, additional fees or penalties often may apply when doing so.
Many installment loan applicants encounter more stringent qualifying requirements that might hinder those with self-employment income or other situations that pose challenges in the verification process.
Pros and Cons of Revolving Credit
Pros
Revolving credit accounts allow borrowers tremendous purchasing flexibility. For example, most local and online retailers and service providers accept credit card payments today and the application approval process often takes only a few minutes.
Certain industries and sectors of the economy, such as many involved in the travel industry, require that customers use a credit card. For example, many airlines require a credit card deposit when booking a flight and some hotels require a credit card when reserving a room.
Hotels and rental car companies might have credit card requirements for confirming a potential customer’s identity, collecting a fee if the reservation is abruptly canceled, or ensuring they collect “incidental” charges for add-on services, damage to a room or vehicle, etc.
Credit card accounts also allow borrowers the flexibility of paying back over time. Keep in mind that repaying a purchase in full at the end of the month may represent a type of “interest-free loan.”
Borrowers with good credit scores often find that revolving credit accounts such as HELOCs and some credit cards offer favorable (low) interest rates, particularly when compared with many personal loans and payday loans.
Many credit cards now offer additional benefits for cardholders including liability protection, travel rewards, and cash back or rebate bonuses.
Cons
While revolving accounts such as credit cards allow increased flexibility and convenience, these features may pose challenges for people with tendencies toward overspending or “impulse buying” if not responsibly managed.
Most types of revolving credit represent unsecured debt, which is often higher interest debt than secured forms—particularly for those with below-average or bad credit.
Consumers must remain diligent when reviewing the terms of credit card agreements, which might contain substantial annual fees and other costs.
Unlike home mortgages and several other loan products, interest associated with revolving accounts generally is not tax-deductible.
How Do They Impact Your Credit Score?
Lenders recognize that a consumer’s past credit history often predicts their future behavior. Therefore, your credit bureau report and credit score play critical roles in eligibility for credit and whether you qualify for the lower, more preferable interest rates.
Installment loans represent opportunities for demonstrating a lengthy history of responsible credit use based on their terms.
Over the course of a multi-year installment loan, a consumer will likely encounter some challenges such as large unanticipated expenses, potential lapses in employment, and other adverse events that could create financial concerns.
Revolving credit accounts also will show how well an individual manages their financial obligations. A credit card account is a clearly more volatile form of debt that varies from month to month and also may continually test a consumer’s spending behavior.
According to Experian, consumers should recognize the importance of having two or more types or categories of credit within their credit history—particularly both installment and revolving accounts.
This concept, referred to as a consumer’s “credit mix”, presents opportunities for demonstrating responsibility across multiple types of debt. Experian estimates that this factor equates to roughly 10% of your overall credit score.
Keep in mind that some types of loans are often issued by organizations that likely do not report lending activity to the major credit bureaus.
The primary types of loans that might go unreported include: payday loans, vehicle title loans, and many car loans issued at “buy-here-pay-here” automobile dealerships. People seeking credit improvement strategies should avoid these options.
Another important factor is your credit utilization rate, which represents a variable that pertains exclusively to revolving credit accounts.
Expressed as a percentage, your utilization rate shows how much of your available credit you currently have in use.
Credit utilization rates or utilization ratios are calculated using the following simple formula:
Credit Utilization Rate = Total Current Debt / Your Total Available Credit
For example, assume you have Credit Card A with a $1,000 balance and $2,000 credit limit and Credit Card B with a $0 balance and $2,000 credit limit. Here, you are using $1,000 of a maximum available $4,000, which equals 25%.
Credit utilization rates are among the reasons why “maxing out” credit cards are typically discouraged. Equifax, one of the three leading credit bureaus, recommends keeping your credit utilization rate below 30%.
Which One Should You Have?
You need both installment loans and revolving credit accounts to build great credit.
The single most influential factor impacting your score is payment history. Regardless of whether you have revolving or installment debt, consistently making timely payments will result in improvement over time.
Your payment history represents approximately 35% of your overall FICO score, which is the industry-leading calculation model. Similarly, VantageScore, the other primary model, states that payment history in their recent VantageScore 4.0 version equates to roughly 41% overall.
Consumers looking for ways of improving their credit should remember the importance of reviewing their credit history each year, which often reveals errors and possible fraudulent activity.
Another choice involves considering a credit builder loan, which is an installment loan option.
CreditStrong helps improve your credit and can positively impact the factors that determine 90% of your FICO score.
