| Types of Installment Loans | Types of Revolving Credit |
|---|---|
| Personal loans | Personal credit cards |
| Mortgages | HELOCs |
| Home equity loans | Business credit cards |
| Auto loans |
Installment Loans vs. Revolving Credit
When is the right time to use an installment loan or revolving credit? The answer comes down to what you need the money for. If you have a planned, predictable expense, an installment loan is generally the best way to go. You’ll know how much you need to borrow and can benefit from the fixed monthly payments. If you have ongoing needs to borrow, revolving credit can give you that flexibility.
Let’s take a look at two hypothetical scenarios:
Sarah is planning a significant home renovation project. She needs substantial money upfront to cover materials and labor costs. In this case, an installment loan could be the better option. She can secure a fixed amount of money with a fixed repayment schedule, ensuring a clear path to paying off her debt while enjoying a lower interest rate.
Tom has been hit with unexpected medical bills and car repairs. He needs access to funds on a more flexible, ongoing basis for these sudden expenses. Opting for revolving credit using a credit card might be the better route for Tom. He will need to be cautious to prevent accumulating high balances and paying more in interest over time.
| Installment Loans | Revolving Credit |
|---|---|
| Lower interest costs over time | Can lead to higher interest costs with revolving balances |
| Fixed monthly payments | Minimum monthly payments based on outstanding balance |
| Access a lump sum upfront | Ongoing access, as long as the balance stays within the credit limit |
| Structured debt, easy-to-budget | Requires self-discipline to avoid high balances |
| Ideal for specific, one-time expenses | Ideal for flexible, ongoing or unexpected expenses |
What are Installment Loans?
An installment loan is a type of borrowing where you receive a lump sum of money upfront, usually for large financial expenses like buying a car, funding a home renovation or even covering education costs. It’s not for your everyday expenses, but for those significant life moments that require a financial boost.
Common examples of installment loans are personal loans, auto loans or mortgage loans.
Imagine you want to buy a car and take out an installment loan for $20,000. This loan comes with a fixed term of five years. Typically, you’ll make monthly payments, covering a portion of the principal amount (the $20,000) and the interest accrued on the outstanding balance.
With installment loans, you know exactly how much you must pay monthly. This predictability can make budgeting and financial planning a breeze. When you make the payments in full and on time every month, you know you can be debt-free after those five years.
While installment loans have a structured schedule, that doesn’t mean they lack flexibility. You can choose a loan amount that suits your needs. You can opt for a higher loan if you need more for a larger purchase. Likewise, you have the option to keep the loan smaller.
What is Revolving Credit?
Revolving credit is a dynamic form of borrowing that allows you to access funds through a line of credit, with a credit limit determined by your creditworthiness. A credit card is the most common example of revolving credit, but other options, such as home equity lines of credit (HELOCs), share this flexible structure.
The defining feature of revolving credit is the freedom it provides in how you use the borrowed funds. Instead of receiving a lump sum for a particular purpose, you have a credit limit as your financial safety net. You can use this credit for whatever and whenever you want, from daily groceries to emergency car repairs.
While revolving credit offers remarkable flexibility, it also comes with responsibility. It’s recommended you make at least a minimum monthly payment, usually a small percentage of your outstanding balance. You can carry a balance on your credit card while repaying it over time, but this convenience may come at the cost of higher interest charges.
As you make payments and reduce your balance, the available credit “revolves” and becomes accessible again. You can keep using the credit as long as you stay within your credit limit.
While revolving credit allows you to carry a balance, it’s generally associated with higher interest rates. To maximize its benefits and minimize costs, paying off your balance in full each month whenever possible is recommended.
Pros and Cons of Installment Loans
Installment loans can be a powerful financial tool to pay for larger expenses, but they have advantages and disadvantages, like any financial product.
Pros and Cons of Revolving Credit
Revolving credit can be valuable when used responsibly, offering unmatched flexibility for everyday expenses and unexpected emergencies. However, it’s crucial to understand the pros and cons before using this financial tool.
Applying for an Installment Loan
Applying for an installment loan involves a structured process, beginning with a needs assessment.
What do you need?: Before you apply, it’s crucial to define your financial requirements, including the loan amount, purpose and monthly payment budget. Not all lenders are the same, so researching lenders, whether traditional banks, credit unions or online options, is vital.
Get prepared: Once you’ve determined your needs and researched potential lenders, gather the necessary documents, including proof of income, identification and proof of residence, as most lenders require these to process your application. Completing the application online, in person or over the phone, entails providing personal information and your requested loan amount.
Get approved: The approval process involves a credit check to assess your creditworthiness. A higher credit score can improve your chances of approval and of getting better terms. Lenders will also verify your income to ensure you can meet the monthly payments. The underwriting department reviews your application, credit report and documents, ultimately making an approval, denial or approval with specific conditions.
Review, sign and receive funds: You’ll receive a loan agreement outlining the terms, including the interest rate, repayment schedule and associated fees, upon approval. Carefully review these terms before signing. After signing, the lender disburses the funds into your bank account, which may take a few days.
Applying for Revolving Credit
Given the multitude of credit card providers, each offering varying terms, features and rewards programs, researching different lenders is crucial. This research helps you align your financial objectives with your preferences. You can compare options online, or you can consult local banks and credit unions.
Gather information: When you’re preparing to complete your application, gather the necessary personal information, including your name, address, Social Security number and employment details. Additionally, you’ll need to provide proof of income, such as pay stubs or tax returns, and identification documents like a driver’s license.
Apply: The approval process involves a credit check to assess your creditworthiness. A higher credit score improves your chances of approval and may lead to more favorable terms and credit limits. Income verification ensures you can manage the minimum monthly payments and handle the credit limit, a critical step for assessing your financial capacity.
Decision time: After reviewing your application, credit history and financial details, the credit provider’s underwriting department will make a decision about your application, which can result in approval, denial or approval with specific conditions.
Credit limit determination hinges on various factors, including creditworthiness, existing credit lines, lender policies and the type of credit card applied for. Once approved, you’ll receive your credit card with a predetermined credit limit.
Alternatives to Installment Loans and Revolving Credit
Managing your finances involves considering various options tailored to your specific needs. In addition to installment loans and revolving credit, you may find that alternative financial tools better suit your particular situation.
When you have multiple high-interest debts, such as credit card balances or payday loans, a personal loan can consolidate your debt into a single, more manageable payment with potentially lower interest rates. Personal loans provide quick access to funds without requiring collateral for unexpected expenses, like medical bills or car repairs. They can also fund home improvements without tapping into your home equity.
Secured credit cards are invaluable for building or rebuilding credit. If you have a limited credit history or a poor credit score, secured credit cards can help improve your creditworthiness. They require a security deposit, making them more accessible to those with credit challenges. They also assist in establishing responsible spending habits without the risk of accumulating high-interest debt.
Budgeting tools through apps or software are perfect for managing your finances and tracking expenses. They help you gain control over your money, save for goals and avoid unnecessary borrowing. If you want to avoid accumulating more debt or falling into a cycle of credit card balances, budgeting tools can effectively curb overspending.
The Bottom Line
Managing your finances necessitates selecting the right credit option. Understanding the distinctions between installment loans and revolving credit, and their respective advantages and considerations, is vital for making informed financial decisions. Installment loans offer structured repayment schedules for specific purposes, whereas revolving credit provides flexibility within a credit limit.
In evaluating your financial goals and needs, consider factors such as the purpose of credit, your comfort with structured payments, your credit score and your spending habits. The choice between installment loans and revolving credit should align with your unique financial situation. Additionally, exploring alternative options such as personal loans, secured credit cards or budgeting tools can complement your financial toolkit and assist you in achieving your goals.
Frequently Asked Questions About Installment Loans vs. Revolving Credit
Missing payments or defaulting on the loan can harm your credit. However, making on-time payments and paying off the loan as agreed in your loan terms can positively impact your credit score.
Depending on the details of your installment loan, you may save on interest costs. However, some lenders may charge prepayment penalties or fees for early repayment. Make sure to discuss this with your lender.
The credit score required for an installment loan varies depending on the lender and the type of loan. Conventional lenders may require a credit score in the good to excellent range, typically 700 or higher. However, some lenders offer installment loans for those with lower credit scores, but they may come with higher interest rates.
Installment loans can be either secured or unsecured. Secured loans require collateral, such as a car or property, which the lender can claim if you default. On the other hand, unsecured loans don’t require collateral but may have stricter credit requirements and higher interest rates.
Editor’s Note: Before making significant financial decisions, consider reviewing your options with someone you trust, such as a financial adviser, credit counselor or financial professional, since every person’s situation and needs are different.
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