Installment vs. Revolving Credit – Key Differences
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- Installment credit accounts allow you to borrow a lump sum of money from a lender and pay it back in fixed amounts.
- Revolving credit accounts offer access to an ongoing line of credit that you can borrow from on an as-needed basis.
- Whether you're choosing an installment or revolving account, the key is to borrow responsibly and keep up with whatever you owe.
Credit accounts are generally divided into two categories: installment credit and revolving credit. Installment and revolving accounts function similarly. Both let borrowers access needed funds, with the understanding that the borrowed money will be repaid over time. However, the terms of this repayment process differ depending on the type of credit account you have.
Find out what installment and revolving credit accounts are. Plus, learn how to spot the key differences between the two.
What is installment credit?
Installment credit accounts allow you to borrow a lump sum of money from a lender. Borrowed funds are paid back in fixed amounts or “installments,” usually on a monthly basis.
Once you pay an installment account in full, your loan is generally considered closed. Should you need additional funds down the line, you'll have to start from scratch and apply for a new loan.
Examples of installment credit
Common types of installment credit include:
- Mortgages that cover the purchase or refinance of a home.
- Auto loans that cover the cost of a new or previously owned car.
- Student loans that cover educational costs, including tuition, room and board.
- Personal loans that cover expenses at a borrower's discretion. You might use personal loans to handle home repairs, medical bills and other unexpected expenses.
What is revolving credit?
Revolving credit accounts offer access to an ongoing line of credit. You can borrow from this line as needed, so long as you don't exceed the credit limit determined by your lender.
With a revolving credit account, you're expected to regularly repay what you borrow. You're generally required to make minimum payments each billing cycle, but you can choose to pay more. If you don't pay your balance in full each cycle, your lender will likely charge interest on what you owe.
Unlike installment credit, a revolving credit account remains open indefinitely. As long as you make your minimum payments and don't exceed your credit limit, you'll be able to draw on your revolving credit as you see fit.
Examples of revolving credit
Common types of revolving credit include:
- Credit cards, the most common type of revolving credit, offer borrowers access to an ongoing line of credit to be used at their discretion. You might use a credit card to cover everyday purchases, a large expense or a costly emergency.
- Personal lines of credit, which allow borrowers to draw money up to a certain limit, function similarly to credit cards. You'll have a credit limit and owe monthly minimum payments based on how much credit you have used. However, you access this money by writing special checks or calling your lender.
- Home equity lines of credit (HELOCs), allow you to borrow against your home's value and are commonly used to fund home repairs or renovations.
How installment credit accounts can impact your credit scores
Installment loans can be helpful in building your credit history over time. Lenders usually prefer borrowers who already have experience using credit, so the longer an account is open, the better. Many installment loans, such as mortgages, have years-long repayment periods, making them a great option for establishing credit long-term.
However, your payment history is usually even more important than the age of your account. Payment history is often considered to be the largest contributor to your credit scores.
Regular, on-time payments help signal your creditworthiness to lenders. So, if you pay back your installment debt according to the terms of your loan, your credit scores may increase. Missed payments, on the other hand, can cause your credit scores to take a serious hit.
How revolving credit accounts can impact your credit scores
Like installment loans, revolving credit accounts can be a great tool to extend the length of your credit history. Revolving accounts are continuous, meaning they'll appear on your credit reports as long as the account remains open.
Your payment history can also affect your credit scores. However, there's another important factor to consider when it comes to revolving credit: your credit utilization ratio. Generally expressed as a percentage, your credit utilization ratio is the amount of revolving credit you're using divided by the total credit available to you. Lenders typically prefer that you use no more than 30% of the revolving credit available to you.
Say you have two credit cards, Card A and Card B. Card A has a $1,000 credit limit and carries a balance of $450. Card B has a $2,000 credit limit and carries a balance of $300. This means your total outstanding debt is $750, and your total available credit is $3,000. Therefore, your credit utilization ratio is $750 divided by $3000, which equals 0.25, or 25%.
When you pay down your outstanding debt, you lower your credit utilization ratio, which can raise your credit scores. You can achieve a similar effect by increasing your total available credit. By contrast, if your credit utilization ratio rises above 30%, your credit scores may drop. So, it's important to keep your credit utilization ratio in mind when considering revolving accounts.
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Installment vs. revolving accounts
When it comes to managing your credit, it's a good idea to have both installment and revolving accounts. Your credit mix is yet another factor that typically contributes to your credit scores. Lenders generally prefer borrowers who can manage many types of credit accounts. For example, if you only have a mortgage and student loans, you may want to open a credit card to add a revolving account to your mix.
Ultimately, the type of credit accounts you own won't make or break your finances. What's the real deciding factor? Your financial behavior.
So, whether you have credit cards, a mortgage, student loans, a HELOC or a combination of accounts, the important thing is to borrow responsibly and keep up with whatever you owe.