Revolving and Installment Credit: What’s the Difference?
In short, revolving credit means you have access to a credit limit set by a lender. You determine how much of that credit limit you will use and pay it off on a monthly basis, with interest if you carry a balance. Meanwhile, installment credit refers to an account where you borrow a set amount of money and agree to monthly payments of a set dollar amount until the loan is paid off.
How revolving credit works
If you have revolving credit (sometimes referred to as a revolving account), you’ll pay down a balance each month but are susceptible to paying potential fees. Credit cards and home equity lines of credit (HELOC) are examples of revolving credit.
The credit limit for revolving credit is established by the lender and can increase or decrease depending on the circumstances. Revolving credit has an interest rate that can fluctuate, so in some cases, your monthly payments may rise.
Although you can carry a balance on a revolving credit account past the payment date, it is financially prudent to pay off revolving debt in full each month. This option of carrying over credit is why it is referred to as revolving credit. In other words, you are “revolving” the balance when you carry it over to a new month.
Pros and cons of revolving credit
- Pro: Consumers choose if and when they want to use their credit.
- Con: You can carry a balance on a credit account to pay at a later date but will be charged with interest. Some credit card issuers also charge annual fees and late payment fees.
- Pro: There is more protection for the consumer if theft or fraud occurs. Revolving credit consumers usually aren’t responsible for any fraudulent charges, a lost/stolen card or identity theft. Review the terms & conditions of your card for full details.
How revolving credit affects credit scores
- Using revolving credit to make purchases can help build your credit score, as long as you make your payments on time.
- Monthly revolving credit payments help you form your credit utilization ratio. Lenders prefer to see lower credit utilization ratios. By maintaining a low balance and making payments on time, you’ll help keep this ratio low.
- If you use revolving credit responsibly, you’ll help build a positive credit history. A longer credit history will generally help you receive a lower interest rate for loans.
How installment credit works
Types of installment loans you may be most familiar with are home mortgages and car loans. Installment loans have your back for life’s bigger expenses.
Pros and cons of installment credit
- Pro: Once you pay off an installment loan, it is considered closed, whereas a revolving account stays open.
- Con: Installment debt typically carries less weight than revolving debt in determining your credit score. This means it won’t have as large of a positive impact on your score as paying off revolving credit will.
- Con: Installment debt generally relies on offering some form of collateral. You may have to use a home or car as collateral that can be used to recoup the lender’s losses if you don’t make a payment.
How installment credit affects credit scores
- If you pay an installment loan in full and on time, that loan will have a positive effect on your credit score.
- A closed account in good standing will stay on your credit report for 10 years.
- Paying off an installment credit loan early is not likely to boost your credit score more than paying it off on schedule.
What to consider when paying off loans
When it comes time to pay off your loans, you have options. How you want to pay off your loans can depend on your specific loan agreements and your financial situation. You could also raise your credit score by paying off either revolving or installment credit, and here are three things you should consider during the process:
- Interest. Any balances carried from month to month on a revolving credit account will be charged with interest, which is then added to the initial principal amount owed.
- Your credit score. Paying off revolving credit can help you lower your credit utilization rate, a key factor in determining your credit score.
- Potential tax benefits. Some installment loans, such as mortgages, qualify you for a tax benefit in the form of interest deductions.
The bottom line
Revolving and installment credit are used for two different purposes. Revolving credit is used as a shorter-term loan (like a credit card), whereas installment credit can be slowly paid off over time depending on the agreement (like with a mortgage). While they are different forms of credit, both need to be paid on time to avoid negatively affecting your credit score.