Deciding between installment loans or revolving credit lines can be challenging. Both have unique benefits and drawbacks to consider based on your financial situation and spending habits. This comprehensive guide examines revolving credit and installment loans in-depth to help you determine which is the better financing option for your needs.
What Are Installment Loans?
Installment loans provide borrowers with a lump sum of money upfront, which is then repaid over a set timeframe in equal monthly payments. These fixed regular payments include both principal and interest until the entire loan balance is paid off.
Common examples of installment loans include:
- Mortgages – For home purchases, fixed over 15-30 years.
- Auto Loans – For purchasing new or used vehicles, fixed over 2-6 years.
- Personal Loans – For debt consolidation or large expenses, fixed over 1-5 years.
Installment loans allow borrowers to finance major one-time expenses like a home, car, or medical procedure over months or years. The fixed regular payments provide predictable budgets compared to revolving credit that varies monthly.
How Do Installment Loans Work?
When applying for an installment loan, the lender evaluates the borrower’s credit score, income, existing debts, and loan purpose to determine approval and create appropriate repayment terms.
Key factors set by the lender include:
- Loan Amount – Based on the purchase price and down payment. Also factoring borrower’s income and credit limits.
- Interest Rate – Based on credit score and market rates. Rates range from 3-36%.
- Loan Term – Typically 2-30 years. Shorter terms have higher monthly payments, longer terms increase total interest paid.
- Payment Amount – Calculated from amount borrowed, interest rate and loan term. Remains fixed for the duration.
Once approved, the lump sum is distributed to the borrower upfront. The loan term begins, with the first payment due the following month. Subsequent fixed payments are made each month until the principal and interest are fully repaid.
Benefits of Installment Loans
Installment loans offer several advantages for borrowers who need financing:
- Fixed manageable payments – Repayments remain constant through the loan term, allowing easier budgeting.
- Interest savings – Interest is charged only on the outstanding principal balance, lowering overall interest costs.
- Lower rates than credit cards – Installment loan rates can be nearly half of typical credit card rates at 12-36% vs 20-30%.
- Can be used for various needs – Installment loan proceeds provide lump sums that may be used as needed by the borrower.
- May improve credit scores – Making on-time fixed payments shows responsible usage, boosting credit scores.
- Consolidate higher interest debts – Can pay off credit card balances or other variable rate debts with lower fixed rate installment loan.
For large expenses, installment loans allow structured repayment without draining cash savings. The fixed schedules make financial planning simpler.
What Is Revolving Credit?
Revolving credit accounts provide flexible access to borrowed funds up to a pre-set credit limit. Unlike installment loans, the balance can fluctuate month-to-month based on spending and payments. Credit cards are the most common example of revolving credit.
Each month, cardholders can spend up to their approved credit limit. The monthly statement shows balances owed, minimum due, payment due date, interest charges, and available credit. Paying the full statement balance avoids interest fees.
Partial payments incur interest on the remaining revolving balance, which stays available for spending if within the credit limit. The unpaid portion revolves over to the next billing cycle if the minimum payment is made, but interest keeps accumulating.
How Does Revolving Credit Work?
Revolving credit cards work through the following process each billing cycle:
- Spending – Cardholder charges purchases and takes cash advances, up to the credit limit.
- Monthly statement – Details all balances, interest fees, minimum payment, and due date.
- Make payment – Cardholder pays minimum, full balance, or any amount in between by the due date.
- Interest charges – Interest accrues on any unpaid revolving balances.
- Repeat – Any unpaid balance minus payments made revolves over as available credit for next month.
Interest compounds monthly on average daily balances if not paid in full. Only making minimum payments results in growing interest fees over time and ballooning repayment costs.
Benefits of Revolving Credit
Used wisely, revolving credit cards provide advantages like:
- Payment flexibility – Option to carry balances at interest over months, instead of lump sum installments.
- Access to funds – Can borrow up to credit limit for ongoing expenses. Easier to get limit increases.
- Rewards – Many cards offer cash back, points, or miles that save money with responsible spending.
- Quick access to credit – Pre-approval makes acquiring emergency funds faster than personal loans.
- May improve credit score – Using below 30% of credit limit and making on-time payments supports credit building.
- Zero interest financing – Some big purchases offer 0% interest for 6-18 months on new card accounts.
However, benefits diminish if payments are missed, interest accrues through revolving high balances, and debt becomes unmanageable.
Installment Loans vs Revolving Credit: Key Differences
|Fixed amount borrowed
|Flexible borrowing up to credit limit
|Fixed payment schedule
|Minimum payment due each month
|Interest charged on outstanding principal
|Interest charged on revolving balance
|Loans closed after final payment
|Accounts stay open if in good standing
|Application approval required
|Pre-approval makes acquiring easier
|Late fees for missed payments
|Missed payments risk account closure and credit damage
|Lower interest rates
|Higher interest rates plus penalties for late payments
While both offer access to financing, the structures differ significantly in terms of flexibility, cost, and impact on budgeting and credit scores.
Which Is Better For You? How To Decide
Choosing between installment financing and revolving credit depends largely on your financial discipline and planned use of funds.
Installment loans are better if you:
- Have a large one-time expense like a home, car, or medical procedure
- Prefer fixed monthly payments to match your budget
- Want to consolidate other higher interest debts
- Need lower interest rates to reduce total repayment costs
- Struggle to control revolving credit card spending
Revolving credit is better if you:
- Frequently make purchases between paychecks and repay monthly
- Can avoid high utilization and make full payments to avoid interest
- Want flexibility of borrowing only what you need monthly
- Seek emergency funds access or 0% financing offers
- Are disciplined about minimizing revolving balances
Your income stability, spending habits, repayment timeline, and aversion to risk also determine which option makes sense. Being realistic about your financial behavior helps select the right financing method.
Tips for Choosing the Best Option
- Compare interest rates on any installment loan offers to current credit card rates to determine most affordable option.
- Review your budget to decide if you can manage set monthly installment payments or need revolving flexibility.
- Check your credit score to see if it meets the approval criteria for the installment loan amount needed.
- Read the fine print on revolving credit offers to understand fees, penalty rates, and rewards terms.
- Calculate the total repayment costs over time for proposed installment loans using online calculators.
- Avoid opening new revolving accounts unless you can pay statement balances in full each month.
- Consider your ability to qualify for reasonable installment loan rates based on your creditworthiness before applying.
Selecting the right financing solution involves weighing your financial situation holistically across factors like expenses, income variability, self-control, and borrowing costs.
Frequently Asked Questions
Which option is riskier for borrowers?
Revolving credit cards carry more inherent risk of debt spirals. As balances roll over month-to-month accruing interest, the total amount owed can snowball quickly. Installment loans with fixed payments pose less risk of uncontrolled growing interest costs.
Which financing option has a bigger impact on your credit score?
Responsible usage of either can build your credit history and score over time. However, missed or late installment loan payments are reported directly to credit bureaus and drastically lower scores. Revolving accounts don’t report late payments until 60-90 days past due, allowing shorter delays to be resolved before credit damage.
Is credit card debt better than a personal loan?
Not necessarily. Paying off high credit card balances with a lower rate installment loan saves substantially on interest over time. And consolidating debts into one predictable monthly installment prevents revolving, growing credit card balances across multiple cards.
Are there alternatives to installment loans and credit cards?
Yes. Options like payday loans, home equity loans, 401k loans, and### Are there alternatives to installment loans and credit cards?
Yes. Options like payday loans, home equity loans, 401k loans, and pawning valuables provide other ways to access funds. However, they come with their own drawbacks and risks.
Payday loans charge excessively high fees and rates while putting your paycheck or car title at risk as collateral if unpaid. Home equity loans also place your home at risk for non-payment. 401k loans reduce retirement savings and may face penalties. Pawning involves temporarily surrendering belongings for a small fraction of their value.
These alternatives ultimately prove more expensive and add risk compared to responsible use of mainstream revolving or installment options.
What credit score is needed for approval of an installment loan?
Each lender sets their own credit requirements, but scores above 620 have the highest approval odds for the best rates on installment loans. Scores under 580 will likely face denial or very high rates. Those with scores in the 580-619 range may need a cosigner to qualify at reasonable rates.
Building your credit score over time through responsible credit management will ensure access to affordable installment loan rates when you need them.
Can you get an installment loan with no credit check?
Some lenders offer “no credit check” installment loans. But this usually signals high risk lending at exorbitant rates exceeding 100% APR. Reputable installment lenders will always check credit reports and scores from bureaus like Experian, Equifax and Transunion to assess default risk before approving loans. Avoid any lender promising guaranteed approvals without a credit check.
How soon after bankruptcy can you get an installment loan?
It is extremely difficult to qualify for most installment loans immediately after declaring bankruptcy. Most lenders require at least 12 months of rebuilding credit with on-time payments before considering installment loan approval. Re-establishing positive payment history on secured credit cards and other debts is necessary to prove you can responsibly manage installment payments after bankruptcy.
Key Takeaways: Choosing Your Best Financing Option
- Installment loans allow fixed, predictable repayment of large lump sum expenses over time. Revolving credit provides flexible access to funds up to a limit and minimum monthly payments.
- Interest on installment loans is charged against the principal. Revolving credit interest accrues on carried balances each month.
- Benefits of installment loans include lower rates, fixed payments, and paying off other debts. Benefits of revolving credit are access to emergency funds and rewards potential.
- Assessing your financial habits, income stability, risk tolerance and borrowing reason helps determine the better financing choice.
- Avoid high-risk alternatives like payday loans. Improve credit scores before applying for installment loans to increase affordable approval odds.
Carefully comparing both options against your spending behavior, budget, credit standing and needs leads to choosing the right tool to meet your financial goals responsibly and cost-effectively.