There is a lot to learn about different types of credit since it can be dangerous when not used properly. Do you know the difference between revolving credit and installment credit? In basic terms, installment credit loans allow borrowers to get the funds right away and start paying it back whereas, revolving credit loans allow borrowers to only pay for what is used.
Let us break down both types of credit to the basics so you can get a better understanding of when to apply for the right type of credit and how it affects your credit score.
With installment credit loans, the borrower receives a lump sum with a fixed interest rate and scheduled payments over a fixed term. Borrowers commonly see this type of loan for mortgages, home equity loans, car loans, student loans, debt consolidation loans or personal loans. Borrowers make payments until it is paid off. After the payoff, the funds are not available to use anymore unless they apply for another loan and starting the process again. It is important to know that with installment loans, there could be a penalty for early payoff. The monthly payments are usually calculated with the interest and principal payments.
Installment credit loans involve a formal application process and has more criteria to meet. Not everyone can get an approval right away and there are more documents that need to be submitted along with an application. The term, rate, and availability of funds is determined by a few factors, including income, credit score, and debt.
Revolving credit loans allows borrowers to spend any amount of funds within their credit limit and pay it off as the borrower uses it. The rate is variable and there isn’t a specific term. Borrowers can use the whole credit limit or some of it. They are only paying for what they are using. Lines of credit, whether it is personal, business, or home equity are all examples of revolving credit. Credit cards are also known as revolving credit loans. Monthly payments can change depending on how much of the credit limit is used.
Applying for a line of credit or credit card is simpler then applying for an installment loan. The limit is still determined by a credit score, income, and debt but in some cases, there are less documents to provide. For example, you wouldn’t need a lot of documentation if you are applying for a credit card. One thing to note is that these types of loan have a variable interest rate which can change at any time.
In terms of a credit report, these two types of credit show up differently. However, both credit types can impact the score negatively when borrowers miss payments or don’t make the minimum payment. Another negative factor that can impact the score is the number of loans that are reported whether it be installment or revolving. For example, it is not in good practice to have too many open loans because as this could lower your credit score as an indicator of a higher chance of missing payments. Too many open loans can deem the borrower as high risk. As complicated a credit score can be, it is important to monitor it to make sure there is the right amount of revolving credit and installment credit. It is key to know how many types of credit loans reported, what is owed, and payment history. Those things impact the score greatly.
- If you are looking for stability, steady monthly payments, and have something in mind that you need funds, an installment loan is the best. It allows borrowers to pay down loans over a certain period of time. It is also easier to budget around the payments since they are the same through the life of the loan.
- If you are looking for flexibility in securing a loan but don’t need the funds right away, a revolving loan could be the best way to do. This will give borrowers easier access to the funds when needed. As mentioned above, revolving credit loans can be used after the initial payoff allowing access to funds multiple times.
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