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Revolving credit and installment credit
Learning the difference between revolving and installment credit can help you pick the best way to borrow money for your needs. Understanding these credit options makes it easier to manage your finances and make wise choices.
What is revolving and installment credit?
Credit is money that you borrow from a lender and agree to pay back later. There are different types of credit, depending on how you borrow and repay the money. Two common types of credit are revolving and installment credit. Let's compare and contrast them using examples of credit cards and personal loans.
Revolving credit
Revolving credit is when you have a limit of how much you can borrow, but you can use it repeatedly as long as you pay back some of it every month. For example, a credit card is a type of revolving credit. You can use your credit card to buy things online, in stores, or pay bills. Every month, you get a statement that shows how much you spent, how much you owe, and how much you need to pay at least. This is called the minimum payment.
You can pay more than the minimum, or even the full balance, if you want to. If you don't pay the full balance, you will be charged interest on the remaining amount. Interest is a fee that the lender charges you for using their money. The interest rate is a percentage that tells you how much interest you pay per year. The higher the interest rate, the more you pay.
Installment credit
Installment credit is when you borrow a fixed amount of money and agree to pay it back in equal monthly payments over a set period of time. For example, a personal loan is a type of installment credit. You can use a personal loan to pay for a big expense, like a car, a vacation, or a home improvement.
You will get a contract that tells you how much you borrowed, how much you need to pay every month, how long you have to pay it back, and what interest rate you will pay. The interest rate is usually fixed, which means it won't change during the loan term. The monthly payment is usually the same every month, unless you pay extra or miss a payment.
How are they different?
Revolving and installment credit are different in terms of repayment, interest, and balance. Here are some ways they differ:
- Repayment: With revolving credit, you can choose how much to pay every month, as long as you pay at least the minimum. With installment credit, you have to pay a fixed amount every month, until you pay off the loan.
- Interest: With revolving credit, the interest rate is usually variable, which means it can change depending on the market conditions or your credit score. The interest is also compounded, which means you pay interest on interest. With installment credit, the interest rate is usually fixed, which means it stays the same throughout the loan term. The interest is also simple, which means you only pay interest on the principal.
- Balance: With revolving credit, your balance can go up and down, depending on how much you use and pay. With installment credit, your balance goes down gradually, as you pay off the principal.
What are the terms?
If you compare the two types of credit based on their terms, you can expect to see something like the following:
Installment credit terms
| Terms: | |
|---|---|
| Principal | |
| Interest rate | |
| Loan term | |
| Monthly payment | |
| Total interest | |
| Total amount payable |
Revolving credit terms
| Terms: | |
|---|---|
| Credit limit | |
| Cash advance | |
| Interest rate/ APR | |
| Minimum payment | |
| Grace period |
With installment credit, you are given a loan of
On the other hand, with the revolving credit, you can borrow up to
What are the advantages and disadvantages?
Revolving and installment credit have advantages and disadvantages, depending on the purpose and situation of the borrower. Here are some of them:
| Type of Credit | Advantages | Disadvantages |
|---|---|---|
| Revolving credit | Flexible and convenient | Risky and costly |
| Can be used for various needs and emergencies | Can lead to overspending and debt | |
| Can improve credit score with timely payments and low utilization | Can harm credit score with late or missed payments and high utilization | |
| Can offer rewards and benefits with some cards | Can charge high interest and fees if not paid in full or on time | |
| Can create a cycle of debt if only paying the minimum or making new charges | ||
| Installment credit | Fixed and predictable | Rigid and limited |
| Can offer lower interest rate than revolving credit with good credit and collateral | Can't be used for other purposes or emergencies without refinancing or taking out a new loan | |
| Can help plan budget and expenses with set monthly payments | Can't be accessed again once paid off | |
| Can build credit history and score with on-time and full payments | Can incur penalties or fees with late, missed, or early payments | |
| Can pay off debt faster and save on interest with extra or payments | Can damage credit score with too many applications or defaults |
How can you use them wisely?
Using revolving and installment credit wisely can help you achieve your financial goals and avoid getting into trouble. Here are some tips on how to use them wisely:
Choose a suitable credit limit or loan amount.
Don't borrow more than you need or can afford to pay back. Consider your income, expenses, savings, and other debts. Use a credit card or loan calculator to estimate your payments and interest.
Pay more than the minimum
Paying the minimum on your credit card or loan will take you longer and cost you more in interest. Paying more than the minimum will help you pay off your debt faster and save on interest. Try to pay the full balance on your credit card every month, or as much as you can. Try to pay extra or make a on your loan whenever you can.
Avoid late fees and penalties
Paying late or missing a payment on your credit card or loan will result in fees and penalties, which will increase your debt and lower your credit score. It will also trigger a higher interest rate, which will make your debt more expensive. Paying late or missing a payment on your loan will also hurt your chances of getting approved for future loans. Pay your credit on time and in full every month, or set up automatic payments or reminders to avoid forgetting.
Compare and shop around
Before you apply for a credit card or a loan, compare and shop around for the best deal. Look at the interest rate, fees, terms, and features of different credit cards or loans. Compare the annual percentage rate (APR), interest and fees. Compare the total amount payable, which is the total amount you will pay back over the loan term, including interest and fees. Choose the credit card or loan that suits your needs and budget.
Want to join the conversation?
in the chart displaying installment credit terms, the total interest is $1280 instead of 8% of the principal $10,000. The section above says that compound interest only applies to revolving credit and installments use simple interest. If this is the case, why does the interest in the example owe $1280 instead of $800?(6 votes)
First thing to point out is that the loan is for 3 years (36 months). The calculation of owing $800 in interest would assume that there were no payments made the entire first year, but in reality that is not the case. The loan amount is decreasing every month, and then interest is calculated on the loan amount remaining for the next 36 months. This results in interest decreasing each month, too.(8 votes)
do we really need money why or why not(2 votes)
We all produce something, and we all need stuff. We don't all produce all the stuff we need. In a cashless economy, you would produce some things in surplus of your needs which you would trade with other people for the extra things that you need but don't produce.
Imagine that you grow bananas, more than you need for eating. Bananas spoil if you keep them too long, so you trade your bananas for shoes. OK. that works. But if, when you need shoes, the person who makes them doesn't want your bananas, what are you going to do?
Money is one way of representing the value of your bananas, and the doctor's way of representing the value of her expertise and ability. We need money because it represents the value of what we produce.(2 votes)
- in the chart displaying installment credit terms, the total interest is $1280 instead of 8% of the principal $10,000. The section above says that compound interest only applies to revolving credit and installments use simple interest. If this is the case, why does the interest in the example owe $1280 instead of $800?(1 vote)
- The simplest answer is because you are making payments from month 1, so your balance is decreasing every month. And interest is calculated on the balance, so as you are paying it off, you are paying less and less interest. Hope that helps.(3 votes)
how did they calculate the monthly payment of $313.36? From what I calculated $313.36 is with interest.
From what I understand from the comments, the interest is calculated from the month's remaining balance. I'm confused where 8% interest is coming from.(2 votes)
Why do early payments result in a fee?(2 votes)
It's relatively rare for early payments to result in a fee, in my experience, but always read the terms of the agreement. As for why, because lenders make money from fees.(1 vote)
What is a lump sum payment?(1 vote)- A lump-sum payment is when something is paid off completely all at once, rather than in several payments over a period of time.(3 votes)
- so when I pay the bank back money and i accidentally overpay do I lose all of that money and have no chance to get it back?(1 vote)
- The bank is licensed to operate honestly and in good faith. Your over payment will be refunded to you.(2 votes)
- I have two questions: What is a cash advance? What does it mean to access a loan (as in "Can't be accessed again once paid off" being a disadvantage for installment credit)?(1 vote)
- A "cash advance" from one of those payday loan places is a high interest loan that you must pay off as soon as you get paid. Stay away from those places. They are very bad for you.
A cash advance from your credit card company is another kind of high interest loan, but not as high as from one of the payday loan places, and you can pay it back over many months, not "all at once". Still, try to avoid it, because it is expensive money.
Revolving and installment credit are kinds of loans to help you make a single purchase. Let's say, you get new living-room furniture on an installment loan. The store loans you the money. BUT, once you have paid it off, that loan is history. If you go back for a bedroom set, you start a new loan, not a "renewed" old one.(1 vote)
- why now we can use it the maney pay you back now(1 vote)
- Why are early fees/overpayment fees a thing? Wouldn't that be seen as a good thing?(0 votes)
- A bank is a profit-making business. It issues credit cards in order to make money for the investors who own stock in the business. The credit cards are for YOUR convenience, but also for the profit of the bank and the dividends that the bank pays to its investors.
When a bank finds a way to legally take money from you, by creating a fee for operating outside of the credit card contract that you signed with the bank, then the bank is doing what it is there to do, make profit for the investors. Whether paying early or overpaying is a good thing or not, the bank sees your "violation" of the contract as an opportunity to get something for its stockholders.(3 votes)