When you need to borrow money, you have two main credit options – installment loans or revolving credit. But it’s not always clear at first glance what type of loan you’re getting. So are personal loans installment or revolving credit?
The answer is that personal loans are a form of installment financing With a personal loan, you receive the full loan amount upfront and repay it in fixed regular payments over a set period of time Revolving credit like credit cards work differently – you have flexible access to borrow up to a credit limit and just make minimum payments monthly.
Below we’ll explore personal loans versus revolving credit in-depth so you understand how they work as borrowing options.
What Are the Differences Between Installment and Revolving Loans?
Installment and revolving loans have some key differences:
Installment Loans
- Get full loan amount disbursed upfront
- Repaid in fixed regular payments
- Interest rate remains the same
- Payments go toward principal and interest
- Has set payoff date when loan balance reaches $0
Revolving Credit
- Approved for a credit limit to borrow against
- Can continually reuse available credit as debt is repaid
- Minimum monthly payment required, not fixed payoff schedule
- Variable interest rate in most cases
- Credit line has no set end date
Installment lending provides a lump sum of borrowed money while revolving credit gives flexible access to available funds up to a limit. Installment loans also have predictable repayment schedules.
Now let’s look specifically at how personal loans work.
Personal Loans Are a Type of Installment Loan
Personal loans provide borrowers with a lump sum of money, up to $100,000 typically. You’ll receive these loan proceeds in full after approval to use for any purpose – debt consolidation, an emergency, medical bills, home improvements or any other pressing need.
With a personal loan you’ll repay the borrowed amount through fixed installment payments usually on a monthly basis. Personal loan lengths often range from 1 to 7 years. Your interest rate and monthly payment stay the same over the full loan term.
Each payment goes toward both principal to reduce the loan balance and interest based on the remaining principal. This structured repayment over a set timeline differentiates installment loans like personal loans from revolving credit.
How Do Personal Loan Payments Work?
Here’s a closer look at how personal loan payments work:
- A set payment amount based on the loan amount, term and interest rate
- Payments are usually due monthly over the loan term such as 36 or 60 months
- Early payoff options are available without prepayment penalties
- Payments apply first to interest accrued and then principal
- With each payment, the loan balance decreases until eventually reaching $0
As an example
You receive a $10,000 personal loan at 10% interest to be repaid over 3 years (36 months). Your fixed monthly payment would be $311.
In the first month, your payment may apply $83 to interest accrued during the month. The remaining $228 would go toward reducing your $10,000 principal balance.
In month two, your payment is still $311 but less goes to interest since your principal is lower. This pattern continues until the loan is fully paid off after 36 months.
The fixed payment schedule makes personal loans easy to budget for. Interest rates on personal loans range from about 5% to 36% depending on your creditworthiness. Excellent credit (720+ credit score) can qualify you for the lowest rates.
Pros and Cons of Personal Installment Loans
Personal loans offer both advantages and potential drawbacks:
Pros
- Fixed interest rates and payments
- Can receive funds quickly often in 1 week or less
- No collateral required like with auto, mortgage and some business installment loans
- Online lenders may offer loans even with fair credit (~640 score)
- Payments and terms clearly outlined upfront
Cons
- Lenders may require income verification documents
- Limited loan amounts usually up to $100k
- Can’t reuse available credit like a revolving account
- Missed payments hurt your credit score
- Late fees if payment is delayed
While the structured payments of installment loans can make borrowing easier, borrowers with lower incomes or unsteady jobs may have trouble affording monthly payments. Job loss or reduced income could quickly make the loan unaffordable.
How Personal Loans Differ From Revolving Credit Lines
Now let’s contrast how personal installment loans work compared to revolving credit options like credit cards.
With a credit card, you’re approved for a credit limit but don’t receive money upfront. You can then use your card to charge purchases or receive cash up to your limit.
You can keep borrowing against your available credit as you repay debt, unlike an installment loan. Your credit card likely has a variable APR that changes based on interest rate moves.
Monthly payments are also very different. Credit card statements have a minimum payment due, often 2-3% of your balance. You won’t have a set payoff date like installment loans unless you proactively pay your balance off each month.
This flexibility can make credit cards more convenient for everyday spending but tempt some borrowers into racking up significant high interest credit card debt. Personal loans have fixed payments and terms so the payoff date is clear.
Below is a comparison of key features between personal installment loans versus revolving credit cards:
| Personal Installment Loan | Revolving Credit Card |
|---|---|
| Fixed interest rate | Variable interest rate |
| Fixed monthly payments | Minimum monthly payments |
| Set payoff date | No payoff date unless you pay in full |
| Receive full amount upfront | Access to borrow up to credit limit |
| No reused available credit | Can reuse credit as debt is repaid |
| Require income/employment verification | Primarily check credit score for approval |
| Refinancing option available | Can do balance transfer to new card |
| Late fees | Late fees |
Should You Use an Installment or Revolving Loan?
So when does it make more sense to use installment financing like a personal loan versus revolving credit?
Benefits of personal installment loans:
- Want fixed loan terms and payment schedule
- Need a large lump sum of financing for a major purpose like debt consolidation
- Don’t want temptation of accessing a large credit line
- Seeking better rates than with high interest credit card debt
Benefits of revolving credit cards:
- Want flexibility to borrow only as needed
- Plan to pay off balance monthly and avoid interest
- Want to earn rewards on spending with rewards cards
- Need to finance an emergency and access cash quickly
Keep in mind that taking on new debt via installment loans or credit cards is rarely advisable unless you have an urgent need or plan that pays off over time. For instance, if you want to consolidate credit card balances to a lower rate loan.
Ideally you should pay for predictable expenses with monthly budgeted income versus borrowing money. And you should also save up over time for larger planned purchases rather than tapping credit.
Alternatives to Borrowing With Personal Loans
If you need money but want to avoid borrowing, here are some options to consider first:
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Use available savings – Avoid debt by depleting your savings account rather than taking a loan. Pay yourself back over time.
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Sell assets for cash – Consider selling unused items, equipment or investments to generate needed cash.
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Employer benefits – Check if your company offers emergency loans, grants or advance paycheck programs.
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Payment plans – Ask creditors about setting up a payment installment plan for existing bills without needing a personal loan.
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Credit counseling – Non-profit credit counseling services can help you budget and discuss options suited to your financial situation.
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Debt management plans – Credit counselors may help you consolidate debt into one monthly payment and negotiate with creditors.
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Balance transfers – Transfer high interest credit card debt to a new card offering a 0% intro APR to save on interest.
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Family gifts – Discuss your situation with family members in case they are willing and able to gift funds.
While personal loans have their place as installment financing, the smart approach is weighing all your options before taking on additional debt. And if you do need a personal loan, shop rates across multiple lenders to find the best rate for your situation.
Finding the Best Personal Loan Lender
If you’ve determined a personal installment loan meets your borrowing needs, here are some tips for getting the best loan offer:
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Check your credit score so you know the rates you may qualify for
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Compare interest rates across multiple lenders, including banks, credit unions, and online lenders
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Look for lenders offering prequalification to check rates without a hard credit check
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Review loan terms and fees carefully to gauge the true cost
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Submit applications to 2-3 lenders to compare loan offers
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Make sure you can afford the monthly payments comfortably
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Pick the lender offering the lowest rates and fees for your situation
As you can see, personal loans are a form of installment financing, not revolving credit. The fixed regular payments over a set repayment term make installment loans like personal loans easy to budget and repay. But only borrow carefully and as needed to avoid getting caught in debt.
Revolving vs. installment credit: Which should you have?
To maintain a good credit score, its important to have both installment loans and revolving credit, but revolving credit tends to matter more than the other.
Installment loans (student loans, mortgages and car loans) show that you can pay back borrowed money consistently over time. Meanwhile, credit cards (revolving debt) show that you can take out varying amounts of money every month and manage your personal cash flow to pay it back.
Lenders are much more interested in your revolving credit accounts, says Jim Droske, president of Illinois Credit Services. So while you may have a large auto loan of over $20,000, lenders look much more closely at your credit cards — even if you have a very small credit limit.
“Assuming both obligations are always paid as agreed, a credit card with a $500 limit can have a greater impact on your credit scores versus a $20,000 auto loan,” Droske tells CNBC Select.
Its important to pay both bills on time each month, as on-time payments make up 35% of your credit score. But only credit cards show if youll be a reliable customer in the long run, he explains. Because your balance is constantly in-flux, credit cards demonstrate how well you plan ahead and prepare for variable expenses.
“Credit scores are predicting future behavior, so the scoring models are looking for clues of your good and bad history,” Droske (who has a perfect credit score) says.
With a credit card, your balance could be under $1,000 in one month, then three times as large the next. If your history shows that you manage your money consistently enough to cover varying costs, then lenders know youre probably reliable enough to borrow more money in the future.
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Having a mix of credit products in your name — such as a couple of credit card accounts and a mortgage or auto loan — helps to strengthen your overall credit profile.
These credit products fall under two main categories: revolving credit and installment credit. Lenders like to see that you have both because it shows them you can manage the many different obligations that come with borrowing all kinds of debt.
While these two kinds of credit are different, one is better than the other when it comes to improving your credit score. No matter the size of the balance, the interest rate or even the credit limit, revolving credit is much more reflective of how you manage your money than an installment loan.
Below, CNBC Select spoke to a credit score expert to understand the difference.
Installment vs Revolving Loans
FAQ
Is an installment loan a personal loan?
Is a revolving loan a personal loan?
Is a personal line of credit an installment loan?
Are personal loans variable or fixed?
Are personal loans revolving credit or installment credit?
Personal loans are considered installment credit rather than revolving credit because they involve borrowing a set amount of money and repaying it in regular installments over a predetermined period. Unlike revolving credit, which offers a line of credit to use repeatedly within a specific limit, personal loans are one-time transactions.
Are personal loans revolving?
Personal loans are considered installment credit because they provide borrowers with a fixed amount upfront, which they repay over time with fixed monthly payments. However, personal lines of credit are revolving, allowing borrowers to borrow and repay the funds as often as they wish.
Is a revolving credit loan better than an installment loan?
If you have a low credit score, revolving credit will likely be more accessible than an installment loan. But keep in mind: Most revolving credit accounts use variable interest rates. And, your minimum payment will also depend on how much you’ve borrowed for the month. Is A Personal Loan An Installment Loan Or Revolving Credit?
How does a revolving loan work?
A revolving loan is issued as a line of credit, where the borrower makes charges, pays them off, then continues to make charges. This is different from installment credit, which comes in the form of a loan that you pay back in steady payments every month. The amount you can charge on a revolving loan is the credit limit, and it can change over time based on your payment history and other factors.