Sometimes, to get ahead a bit, we borrow money. There are two main types of credit people apply for when they need to borrow: installment loans and revolving credit.
Each form of credit has its advantages and disadvantages. When trying to improve your credit’s health, it’s important to know the difference between the two.
It is a good idea to have both types of credit attached to your name for your future borrowing needs. If you handle your finances responsibly and make your payments on time, then these credit accounts can improve your credit score.
When it comes to installment loans vs revolving credit, they both might be important for your credit score, but one can have a bigger impact on your results. We’re going to go over the differences between the two types of credit so you will understand which one is right for you.
Revolving Credit
Revolving credit is a type of loan that doesn’t have a set payment schedule. Once the borrower pays back what is owed, then they can continue to borrow the money again whenever they need it. Essentially, a revolving credit line asks you to pay back what you spend in monthly payments.
The most popular forms of revolving credit are credit cards and lines of credit. As long as the borrower doesn’t go over their limit, then the money will be there for them to use whenever they need it. If used responsibly, this form of credit can be useful in an emergency.
Installment Loan
An installment loan is a personal loan which the borrower can pay back over time in set amounts. These are usually set to a manageable amount that the borrower is capable of meeting on either a weekly, bi-weekly, or monthly schedule. Most people use installment loans to purchase assets and to pay recurring bills.
Installment Loans vs. Revolving Credit: Comparing the Cost of Borrowing
Your credit score will play a big role in what your interest rates are for both installment loans and revolving credit options.
If you want the lowest interest rates, then you need to make all of your payments on time. Poor credit means higher interest rates.
When it comes to interest rates, installment loans are a little bit friendlier than revolving credit. Installment credit loans usually start with an interest rate of around 2% for secured loans (secure means the loan is backed up with collateral like a house or a car) and 18% for unsecured loans (an unsecured loan does not have any collateral).
Revolving credit can be a bit more expensive when it comes to interest rates. Your interest rates depend on your existing credit score and can range anywhere from 9%-25%. If your balance doesn’t get paid in full, then that interest charge gets carried over into the following month. This can work out to be more expensive in the long run.
If you find yourself in a situation where your borrowing of revolving credit got too high, then the option of using an installment loan to pay it off will leave you with less interest to pay off. If you think it may take a year to pay off what you borrowed, wouldn’t a rate of 2% interest be better than 25%?
Installment Loans vs. Revolving Credit: Comparing Payments and Conditions
When it comes to comparing payments and conditions, revolving credit is a much more flexible option—more information here from Self.com.
Revolving credit will require a minimum monthly payment of the interest plus any additional fees. If you are unable to pay off the full balance, it will just carry on to the following month.
An installment loan is always loaned out on a fixed payment schedule. At the time of the loan’s approval, the monthly payment will be automatically calculated for you. Your lender should tell you that information upfront.
One huge disadvantage that some installment loans come with is a pre-payment penalty. This means that if you want to pay back your loan early, then you will be charged a fee for that. This is one thing you never have to worry about with the payments and conditions of revolving credit.
Installment Loans vs. Revolving Credit: Comparing the Impact on Your Credit Score
Let’s get one thing straight: making your payments on time will have a positive impact on your credit score. This goes for both forms of credit. It’s the easiest way for anyone to improve their credit score. On the other hand, missing your payments is a surefire way to tank your credit score.
It is important not to miss a payment on any of your revolving credit accounts because 40% of your credit score is determined by your payment history. Making your minimum payment is necessary if you want to avoid the long-lasting impact this bruise could cause on your credit score.
Installment loans can have a better impact on your credit score than revolving credit because once you’re done paying it off, the balance stays at zero. If you have successfully made all of your payments on time, then it’s easier to manage a good credit score.
It’s a little bit trickier to manage all of your payments with a revolving credit line because it’s at your hand to use whenever you please. It’s far too easy to re-spend the money once you have paid it off. Whereas an installment loan is over once you reach a balance of $0; you can’t reuse it.
The Best Choice to Improve Your Credit
Both installment loans and revolving credit are necessary for improving your credit score. When you apply for any type of loan, lenders want to see that you have both types of credit to your name. This shows them that you can manage the obligations that come along with borrowing money.
Installment loans may seem great because you can pay them off on time and be done with them. If you can manage to make all of your payments on time, then you will see your credit score rise—more information here from SimpleFastLoans.com.
However, revolving credit plays a more important role in improving your credit score. Having a positive payment history with your revolving credit accounts will show lenders that you are more responsible. These accounts have money that is available at your disposal anytime you want. If you can manage that responsibly, that shows lenders that they can trust you to meet the obligations attached to borrowing money.
Your revolving credit score can also give lenders more insight on your borrowing behavior than installment loans do. Revolving credit allows the borrower to make a lot more decisions with their credit than an installment loan. Using that credit to make responsible choices will show lenders that you are ready for a bigger loan when you apply.
