Personal loans can be a great way to finance large purchases or consolidate debt. But before taking one out, it’s important to understand the key differences between installment and revolving credit. This article will explain if personal loans are installment or revolving credit, and help you determine which type of financing may be better for your needs.
What is a Personal Loan?
A personal loan is money borrowed from a bank, credit union, online lender, or other financial institution. The borrowed amount is given as a lump sum upfront, which you then repay in fixed monthly installments over a set period of time (usually 2-5 years).
Personal loans are considered unsecured debt since they are not backed by any collateral Lenders assess your creditworthiness and income to determine if you qualify. Interest rates and terms vary by lender but are generally lower than credit cards
Personal Loans are a Type of Installment Credit
Personal loans fall into the installment loan category Here’s why
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You receive the full loan amount upfront: With a personal loan, you receive the entire loan amount you borrowed as a lump sum when the loan closes. This differs from revolving credit where you access funds as needed.
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Fixed monthly payments: Personal loans have regular equal payments that pay down both principal and interest until the loan is fully paid off. Your monthly payment stays the same over the life of the loan.
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Set repayment term: Personal loans have a definitive end date, usually 2-5 years. You pay the loan in full by the maturity date. Revolving credit has no set endpoint; you can carry a balance indefinitely as long as you make minimum payments.
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Interest rates are fixed: Personal loan interest rates remain the same over the full term. Rates on revolving credit like credit cards can fluctuate over time.
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You can’t reuse the funds: Once you receive the loan amount, you can’t borrow against that balance again like you can with a credit card. You’d need to apply and qualify for a new personal loan if more funds are needed.
Major Examples of Installment and Revolving Credit
To understand the key differences between installment and revolving credit, it helps to look at some major examples of each:
Installment Loans
- Mortgages
- Auto loans
- Personal loans
- Student loans
- Appliance and furniture loans
Revolving Credit
- Credit cards
- Home equity lines of credit (HELOCs)
- Overdraft protection
- Business lines of credit
Installment and revolving credit have unique advantages and disadvantages that make them suitable for different borrowing needs.
Benefits of Installment Loans
Predictable payments. Installment loans have predictable, fixed monthly payments that fit into your budget. You know exactly what to expect each month.
Lower interest rates. Installment loans generally have lower interest rates compared to revolving credit. For example, the average credit card rate is around 17% while personal loan rates can be as low as 4%.
Fixed payoff date. With installment loans, you know the exact month your loan will be paid off if you follow the repayment schedule. There’s no risk of getting stuck in a debt cycle.
Easier to qualify. Lenders have more lenient approval requirements for installment loans compared to revolving credit. Minimum credit scores are lower and debt-to-income ratios can be higher.
Can build credit. Making on-time installment loan payments shows lenders you can manage credit responsibly over an extended timeframe. This can help improve your credit standing.
Drawbacks of Installment Loans
Less flexibility. You receive the full loan amount upfront in a lump sum. If you end up not needing all the funds, you’re still on the hook for repaying the total borrowed amount plus interest.
Loan limits. Most lenders max out personal loan amounts at $40,000 – $50,000. If you need to borrow more, installment loans may not be an option.
Longer application process. It takes more time and paperwork to apply and get approved for an installment loan versus simply getting approved for a credit card.
Tougher to qualify. Lenders have stricter approval criteria for installment loans than revolving credit. If you have bad credit or high debt levels, you may not qualify.
Prepayment penalties. Some installment loans charge fees if you pay off the balance early. You need to check if prepayment penalties apply before borrowing.
Pros of Using Revolving Credit
Spend only what you need. With credit cards and lines of credit, you can access funds as needed up to your credit limit. You only pay interest on the amount used.
Fast access to cash. In an emergency, revolving credit gives you immediate spending power up to your available credit. Installment loans require a lengthy application process.
Flexibility in repayment. Credit cards have minimum monthly payments, so you can adjust repayments based on your cash flow as long as you make the minimums.
Easier approval. Lenders have lower credit score and income requirements for revolving credit compared to installment loans.
No loan limitations. Credit cards often have very high limits, so revolving credit works better than installment loans if you need to finance large purchases.
No prepayment penalties. You can pay off credit card balances early with no extra fees. This isn’t always the case with installment loans.
Drawbacks of Using Revolving Credit
Variable rates. Interest rates on revolving credit fluctuate over time causing monthly payments to change. Rates for installment loans are fixed.
Higher interest rates. The average credit card interest rate is around 17% while personal loan rates start as low as 4%. Revolving debt is usually more expensive.
Risk of ballooning balances. There’s no set payoff date with credit cards. You could carry debt indefinitely, causing balances to balloon if only making minimum payments.
Can hurt credit scores. Maxing out cards or having high revolving utilization drags down credit scores. Managing installment debt helps scores rather than hurts.
Prequalification limitations. You usually need to apply and get approved for a specific installment loan amount. But with credit cards, approval is for a maximum limit that you may not use fully.
Spending temptation. The ease of swiping a card makes it tempting to overspend. Having a fixed installment loan payment can impose better spending discipline.
Which Type of Credit is Right for You?
So should you use an installment loan or revolving credit for your next financing need? Here are some guidelines on when each borrowing option may be preferable:
Installment loans are better for:
- Large, planned expenses like a home remodel
- Paying off high-interest credit card balances
- Major life events like a wedding or adoption
- Building up your credit history
Revolving credit is better for:
- Unexpected emergencies when you need money fast
- Purchases under $1,000 that you can quickly repay
- Times when you need purchasing flexibility and don’t want to apply for a specific loan amount
- Building up an emergency fund
- Financing a small business
The bottom line is installment loans work for predictable borrowing needs while revolving credit accommodates more flexibility and spontaneity. Assess your specific situation to decide which type of financing makes more sense.
Tips for Managing Installment and Revolving Credit
Here are some tips to manage both installment loans and revolving credit successfully:
- Only borrow what you can realistically afford to repay
- Try to pay more than the minimum payment on credit cards
- Pay off cards with the highest interest rates first
- Check your credit reports regularly for errors
- Create a budget to manage monthly loan payments
- Build emergency savings for unexpected expenses rather than relying on credit
- Be cautious of cards with high credit limits that encourage overspending
- Set up automatic payments on installment loans to avoid late fees
The Takeaway
Personal loans fall into the installment loan category, where you receive a lump sum upfront and repay it with fixed monthly payments over a set timeframe. This differs from revolving credit like credit cards where you can continually borrow up to your limit.
Carefully consider your needs and financial situation when deciding between installment financing versus revolving credit. Their unique advantages and disadvantages make each option better suited for certain borrowing situations. With prudent use, both installment loans and revolving credit can be useful ways to make major purchases while building your credit.
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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.
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.
Installment vs Revolving Loans
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.
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?
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.
Are personal loans revolving or installment debt?
Now that we’ve clearly defined installment and revolving debt, you might be wondering which category a personal loan fits into. Since personal loans are repaid in fixed monthly payments over a repayment term, they’re considered installment debt.