One common part of being an adult is learning to handle your finances. Unfortunately, this often includes being in some kind of debt.
If you’re looking for someone to finally explain the difference between revolving debt vs installment debt, we’re here to help. We understand that debt can sometimes be confusing and overwhelming, so in this article, we will do our best to:
- Explain revolving debt
- Explain installment debt
- Include a pro and con list for each of them
- Talk about their impact on your credit score
- Help you decide which one is a better choice for you
- Answer FAQs
Revolving Debt vs Installment Debt
Let’s see what the main differences between these two types of debt are.
What is revolving debt?
Revolving debt is one of the most common types of debt among Americans. It’s popular because it’s a quick and convenient way to get some extra money. Revolving loans are a good option for getting extra money for small to moderate expenses. For larger investments and purchases, such as a car or a house, installment loans would be a better choice.
A revolving debt doesn’t require fixed monthly scheduled payments. You have a limited amount of money that is available for you to borrow from at any time. You can borrow any amount so long as it’s below the maximum revolving credit limit.
As for returning the money you have borrowed, you have a few options since the amount you pay each month isn’t fixed. If you choose to repay the same amount you borrow each month, you can do so with no interest. However, whenever you return less than you borrowed and there is still some debt left on your balance, you will be charged interest with each payment you make. The interest rate increases the longer you wait to repay your full balance. You can keep taking and returning money from your balance for as long as you want to. This is why these debts are called revolving.
Here are the most common revolving credit examples:
Examples of revolving debt
These are payment cards that can be used to pay for goods and services using borrowed money that is repaid later, usually with interest. They are typically issued by a bank or a company offering financial services.
A retail card is a type of credit card that can only be used at a particular retailer / group of retailers. It usually comes with certain perks such as special discounts or reward points.
Home equity line of credit
This type of debt, also known as a HELOC, works similarly to the other revolving payment types, but unlike them, this one is secured. You borrow from the equity on your home similarly as you would from a credit card, and your home is used as collateral.
Pros and cons of revolving debt
- Flexible repayment – no fixed monthly installments
- Readily available funds
- No approval waiting time
- Long-lasting source of funds
- High interest rates
- High fees (annual, origination, commitment fees)
- Possible negative impact on credit score
What is installment debt?
Unlike the flexible nature of revolving debt, where you choose the amount you pay each month, installment debt is repaid in fixed monthly installments, hence its name. Installment loans are usually taken out in order to cover some more considerable expenses or to consolidate debt.
In order to qualify for an installment loan, you need to pass an approval process that checks various aspects of your financial situation. Some things that are assessed are:
- Credit score – you’re less likely to get approved for a loan if you have bad credit
- Credit history – checking your payment history for any instances of late or missed payments
- Debt-to-income ratio – making sure you aren’t in too much debt and have enough income to eventually pay off the installment balance
Your interest rate will also vary according to your financial situation – the better it is, the lower the interest rate you will get. However, compared to revolving debts, installment debts usually have lower interest rates, unless you have a bad credit score. That still doesn’t mean there aren’t any installment loans for bad credit. Getting an installment loan approval leaves you with a fixed debt that you are expected to repay in full in a certain amount of time.
Examples of installment debt
A personal loan can be used for financing many endeavors: holidays, special events, medical bills, car/home repairs, and debt consolidation, to name a few. Many lenders offer personal loans, and they are worth looking into if you are planning any considerable expenses.
Mortgages are one of the most common examples of installment loans. Being able to buy a home without any financial aid is very rare nowadays, and that’s where a mortgage comes in – it provides the extra funds.
Being a part of the American school system isn’t cheap, especially for a student, which is why most of them are forced to take out special loans to fund their education. This type of debt is notorious for being difficult to pay off, especially if the student struggles to find a lucrative job after graduation.
Also called an auto loan, this loan is taken out for the purpose of buying a new vehicle. They are great for your credit history and require no collateral. This is an installment loan with usually low interest rates.
Small business loans
A small business loan helps jumpstart a small business and give it the push it needs to get on the market and succeed. It can also help an already functioning small business expand. After the business grows, paying off the loan would be an easy task.
If you rely on expensive equipment for your business to run smoothly and lack the funds to purchase it, an equipment loan can cover the costs while you pay it off over time in installment payments.
Pros and cons of installment debt
- Lower interest rates
- You can anticipate and plan your fixed payments
- Borrow considerable sums of money
- Consequences if you fail to pay
- Increasing interest rate over time
How do revolving and installment debts influence your credit score?
Your credit score is one of your most valuable assets when applying for a loan, so it’s vital that you keep working to improve it. There are lots of factors that can determine your credit score, but here is how revolving and installment debt impact it:
Revolving debt impact on the credit score
Depending on the way you use it, revolving debt can have either a positive or negative impact on your FICO credit score. Getting a credit card can be an excellent way to build credit if you have no credit history, but you need to be careful – poor revolving credit management can do more damage than good.
Your payment history accounts for 35% of your credit score, so if you want to make a significant impact, it can be as simple as controlling your payments.
Missed or late payments
Make sure to make all payments regularly and before their due date to significantly build your credit score over time. If you fail to do this, the opposite can happen, and your score will suffer.
Credit utilization ratio
Keep that credit utilization ratio in control, ideally under 30%. Revolving debt is very accessible and convenient to use, but relying too much on your credit is not a good option. If you are smart with keeping your revolving balances low, you can boost your credit score.
Installment debt – impact on the credit score
Your credit can also be impacted either positively or negatively by installment debt, although the impact may be more subtle compared to revolving debt. You’ll most likely see a difference later rather than sooner. Here are the effects installment debt can have on your credit score:
As we already mentioned before, your payment history has the biggest impact on your credit score. Making your payments regularly and on time benefits your credit score in the long run since it’s proof that you are a reliable borrower who can successfully manage your debts.
Missed or late payments
The consequences of missed or late payments on your credit score are the same as with revolving debts – they can have a hugely negative impact on it, so make sure you make your payments on time by setting up autopay or monthly reminders.
Installment loans can help you build credit in a few ways:
- By diversifying your credit mix if you only have credit card debt;
- By reducing your credit utilization ratio in the case of credit card debt consolidation;
- By steadily increasing your credit score if paid off regularly and on time.
How To Choose Between Revolving Debt vs Installment Debt?
At the end of the day, it all depends on your personal needs. Having both revolving and installment debt makes a good credit mix that can impact your FICO score positively. However, if you are adamant about choosing one, here are our two cents on the matter.
If you can handle it responsibly, revolving credit is a great option for:
- Young adults who need to build credit
- People who prefer flexibility with their monthly payments
- Smaller purchases and expenses
On the other hand, installment loans are an excellent option for:
- Significantly bigger expenses (house, car, business equipment);
- People who prefer stability and consistency in their monthly payments;
- Debt consolidation for your credit cards.
Being in debt is not always a bad thing and can have many benefits if you choose the right type for yourself and learn to make the most of it. We hope our article clarified the differences between revolving debt vs installment debt and provided a clear overview of how they work as well as their possible effect on your credit score. Handling debt is no easy task, and we’re here to guide you through the process and help you achieve financial stability.
Make sure you have an accurate estimate of the amount you owe, and then make an action plan. Do your best to make all your payments on time to avoid any additional fees or a higher interest rate. Consider starting an extra job, borrowing from a friend, or taking out a personal loan to consolidate your previous debts.
Yes! Taking out an installment loan can reduce your credit utilization if you already have credit card debt. It can also boost your credit score if you finish your monthly payments regularly and on time, and it can be an excellent addition to your credit mix.
Yes, that is an option, but it’s one that we wouldn’t recommend. Why? Well, a home equity loan is a type of a secured loan, meaning that in case you don’t have money to pay it off, you risk foreclosure of your home. We think that is too big of a risk to take.
Yes, student loans are a type of installment loan. This means that you borrow a large sum of money that you pay out in fixed monthly increments until you have returned the whole amount you borrowed in the first place (with interest, of course).
There is no winner in the revolving debt vs installment debt battle. Both types can have many benefits as well as negative consequences on your credit score and financial situation. The main thing that matters are your financial needs and which debt will satisfy them.