Having credit can help boost your overall credit score and be used to finance purchases, like a new home or an unexpected medical bill. There are two types of credit – installment loans and revolving credit.
While you can use both types of credit to manage your finances, each has its own set of terms, repayment schedules, and interest rates. And one type is better than others when building up your credit. Here’s what you need to know about installment loans and revolving credit.
What is an installment loan?
An installment loan is a loan you pay back over a set period. Borrowers receive the entire lump sum and repay the loan in scheduled payments. The repayment terms can be a few months to a few years. You can be charged a fixed or variable interest rate and other fees.
You can only borrow money from an installment loan once, and you’ll need to apply for a new loan if you need more money. Lenders will consider credit history, outstanding debt, credit scores, and other factors when extending an installment loan.
Installment loan examples
Installment loans are a popular way to finance big-ticket items like houses or cars.
The most common installment loan types include:
Impact on credit score
Making consistent on-time payments toward your installment loans can help strengthen your credit score. Payment history is a huge factor in determining your credit score, so making timely payments can help your credit. And it can help increase your credit mix, which considers the different types of accounts you own.
However, an installment loan might not positively impact your credit score immediately; in some cases, it could lower your score. Maintaining on-time payments can help mitigate those effects.
Installment loan pros and cons
|More flexible terms and lower interest rates than revolving credit.||Can have strict eligibility requirements.|
|Can be used for large expenses.||Fees and penalties can be high.|
|Repayment is straightforward and at the same time each month.||Can take a while to pay off.|
|Can potentially raise your credit score.||If you need more funds after you spend the initial loan amount, you’ll need to apply for a new loan.|
What is revolving credit?
Revolving credit is when you borrow money repeatedly, up to a specific limit. Borrowers have access to this line of credit whenever they need it and can choose to use it or not. There’s no set repayment schedule; you must repay what you borrowed and any interest owed.
Revolving credit examples
The most common example of revolving credit is a credit card. Credit cards give borrowers an endless way to borrow money (up to a certain amount) for both large and small expenses.
Other types of revolving credit include:
- Personal line of credit
- Home equity line of credit (HELOC)
Impact on credit score
Responsible usage of your revolving credit can help improve your credit score, just as it would with an installment loan. But in addition to payment history, revolving credit will also impact your credit utilization ratio. This ratio reflects how much you owe in comparison to how much available credit you have. After payment history, your credit utilization is the second most crucial factor determining your credit score, so you’ll want to keep your credit utilization low (below 30%).
Revolving credit pros and cons
|Only charges interest on the amount borrowed.||Higher interest rates than installment loans.|
|Funds don’t expire.||The approved loan amount tends to be lower than the financing from an installment loan.|
|Good financing option for short-term needs.||It may come with added fees and penalties.|
|Tends to have more straightforward eligibility requirements and faster access to funds than an installment loan.||Repayment needs to be more structured and can be challenging to track.|
What are the key differences between installment loans and revolving credit?
Here’s a summary of the main differences between installment loans and revolving credit.
|Installment Loan||Revolving Credit|
|Borrowing||One lump sum||An open-ended credit line that you can borrow from regularly|
|Examples||Auto loans, student loans, mortgages, personal loans||Credit cards, personal lines of credit, HELOCs|
|Interest Rates||Lower interest rates||Higher interest rates|
|Repayments||Monthly fixed repayments||Non-fixed repayments on the balance|
|Interest Charged||On the total amount borrowed||On the amount withdrawn|
|Qualification||More requirements; harder to qualify for||Fewer requirements; easier to qualify for|
|Credit Score Impact||Has an impact on your credit score||Has a more significant impact on your credit score|
Which should I choose?
Installment loans and revolving credit each have their pros and cons. They both can be helpful ways to finance a considerable expense or help build your credit. But they can also harm your credit if you don’t manage your debt.
When considering which type of credit to get, consider why you need a loan. For example, an installment loan will make more sense if you want to finance a new car than a revolving line of credit. That’s because you’ll get the money you need in a single lump sum and can pay it back over a fixed time. On the other hand, a credit card might be a better option if you want to buy a new laptop and need financial help.
It’s common to manage multiple forms of credit, as each has its benefits, and having a mix of both can help your credit score. The important thing is that you don’t bite off more than you can chew – only open a line of credit if you can afford to pay it back on time.
Is a payday loan an installment loan or a revolving line of credit?
A payday loan is not an installment loan. Payday loans are typically paid back in a lump sum after your next payday.
Payday loans also aren’t revolving lines of credit as they aren’t meant to be open-ended lines of credit. Many financial experts consider payday loan lenders to be predatory, and getting a payday loan can keep you in a cycle of debt. Consider alternative options.
Is a personal loan installment or revolving?
A personal loan is an installment loan because it lets consumers borrow a certain amount of money for a wide range of needs. You can use a personal loan for many things, from paying off student loans to buying a new car.
Is a small business loan installment or revolving?
There are different types of small business loans. Some small business loans are installment loans, while others are revolving credit. Installment loans are the more common type of small business loan, but consumers can also open a business line of credit. Which kind of loan to take out will depend on your business needs.
Using both types of loans to build your credit
Managing different types of credit is ultimately beneficial for your credit score. It shows lenders that you’re a responsible borrower and can handle your credit usage.
Having both an installment loan and revolving credit can help build your credit score and make it easier for you to obtain financing in the future. Just ensure you’re not opening more credit accounts than you can reasonably handle – missed payments can severely impact your credit score and creditworthiness.
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