The world of debt can be overwhelming. Whether you’re planning a future home purchase or looking to open a new credit card, you’ll be engaging with debt. The question is: which kind of debt?
You may have heard of the phrases “revolving debt” and “installment debt.” These are the two main types of credit repayments. And although they are similar (both can enable you to make purchases and both impact your credit score), the way they work is vastly different. A simple way to understand the difference is that revolving debt works like a credit card and installment debt works similar to a mortgage loan.
In this guide, we’ll dive into the differences between installment vs revolving debt.
What Is Revolving Debt?
So, what is revolving debt? Think of revolving debt like a revolving door. You can repeatedly access the building of credit, but in order for you to make a second lap, you’ll have to finish the first loop (i.e., you’ll need to pay the first debt amount).
Revolving debt involves a three-step process:
- The lender sets a credit limit, which is the amount of money that a borrower can access.
- The borrower can spend all of their credit limit in one go or slowly over time.
- Once the borrower has repaid what they’ve spent, the credit cycle starts all over again.
There are a couple of industry practices to bear in mind with revolving debt:
- Although, technically, you can reach your credit limit as often as you like, doing so will negatively impact your credit score. About 30% of your credit score is determined by your “credit utilization ratio,” which means how close your credit card comes to hitting its limit. Carrying a high balance on your cards will lower your credit score.
- Revolving debt often comes with higher interest rates. These interest rates compound each month that you leave a balance on your card. You can avoid interest payments by paying off your balance in full each month.
- You may be subject to high fees for late payments or exceeding your credit limit.
- Credit cards may offer reward points or bonuses when you use them — but they may also tempt you into spending more than you can afford.
Because you are not required to pay back your debts within any set time, revolving debts can quickly accrue interest and even become unmanageable. If you are opening up a line of credit account, be careful not to purchase more than you can pay back.
What Is an Example of Revolving Debt?
The most common example of revolving debt is credit cards. You, the creditor, are set a credit limit by your credit card company. Your credit limit is the amount of money that you can spend on your card.
Say you have a credit limit of $1,000, and you spend $600 on your credit card. Now, you only have $400 left in credit until you reach your limit. But if you pay back all $600 of debt, you’ll once again be able to access all $1,000 of credit.
You are not required to pay off debt in full at any time. However, the debt that you don’t pay off will accrue interest. That said, if you aren’t on top of your payments, you could fall into revolving debt, scrambling to figure out how to get rid of revolving credit debt.
Lines of credit (LOCs) are also another common example of revolving debt. LOCs are available for both personal and business accounts. Interest rates fluctuate and if you miss a payment, you’re less likely to be given a grace period.
What Is Installment Debt?
Whereas revolving debt can be borrowed again and again, installment debt is one lump sum that you pay off over time. The process of taking on installment debt is fairly straightforward:
- You take out a loan for a set amount, with an agreement to pay back that loan over a set period of time.
- You begin paying back your loan, according to the terms you agreed upon. Generally, this includes monthly payments.
- When you pay off the entirety of your debt (and any interest that may have accrued), the credit cycle is closed.
Although the sum you’ve borrowed may accrue interest over time, the amount of money that’s being lent to you will not change. When signing the lease, you’re agreeing to a fixed schedule wherein you’ll pay a set amount each month over the course of the loan’s term.
There are a few terms to know if you’re thinking about taking out installment debt:
- Principal – This is the total amount you are being lent.
- Amortization schedule – The schedule denotes your terms for repayment.
- Prepayment penalty – This fee may apply if you pay off your loan early to avoid accruing interest.
- Payment history – This is a record of whether or not you’ve made all of your payments. Failing to do so can negatively impact your credit score.
It may be more difficult to secure an installment debt than a revolving debt. Before giving you a loan, creditors may check your:
- Credit score
- Other outstanding debts
What Is an Example of Installment Debt?
Installment debt is a fairly common credit repayment form for many of life’s biggest moments. Some common forms of installment debts include:
- Student loans
- Auto loans
- Personal loans
- Payday loans
What Is the Difference Between Installment Debt and Revolving Debt?
Although both installment debt and revolving debt may help you make some of your life’s most important purchases, there are several differences between them, including:
- Renewal – The major difference between installment debt and revolving debt is that once you pay off an installment debt, you are done. Revolving debt can be borrowed as many times as you pay it off.
- Accessibility – It may be more difficult to qualify for an installment debt plan than revolving debt.
- Interest rates – Revolving debt typically comes with higher interest rates than installment debt.
- Amount – With revolving debt, there is no limit to the amount of credit that you can access over time if you pay back your debts each month. Installment debt is a set borrowed amount. If you need more, you’ll have to apply for another loan.
- Time limits – Installment debt must be repaid within a set period of time. There are no time limits for revolving debt.
- Credit Utilization Ratio (CUR) – Your CUR, an important factor of your credit score, will not be impacted by installment loans.
But what about the similarities between them? The scheme may be different but how you pay either can affect your credit scores, interest rates, and loan amount. If you want to remain having good credit and avoid bad credit, always review your credit report, credit history, and credit limit to stay on top of your installment accounts and revolving credit accounts.
Are Credit Card Loans Installment or Revolving Debt?
This is where things may get a bit tricky. You now understand that any purchases you make with your credit card are a type of revolving debt. But what happens when you take out a loan to pay off your credit card debt?
If you take out a personal loan to pay off your credit card debt, you will be taking on an installment debt. This type of debt typically comes for a fixed amount and with fixed terms. Every month, you’ll make a payment until you’ve paid off the loan. This can be a smart option for people looking for:
- Structured payment plans
- Lower interest rates
Generally, it is not possible to pay off your credit cards with another credit card. You could pay off a credit card with a cash advance from another card but, due to high fees for cash advances, this is usually not suggested. It could end up with you landing in deeper debt.
Improve Your Financial Stability With a Sale-Leaseback
While you may be debating taking on revolving debt vs installment debt ahead of your next big investment, a sale-leaseback can help you avoid predatory interest rates and fees. This unique solution can help you unlock the equity in your home without having to leave it.
How does a sale-leaseback work? When you sell your home using a sale-leaseback program, you’ll convert your home equity to cash, which you can spend in any way you choose. There are a variety of sale-leaseback benefits, and depending on your program, you may be able to stay in your home as a renter for prolonged periods of time, have the option to buy it back, or have the option to sell it on the open market. If you’re looking to move on to bigger and better things, you can also use the cash from a sale-leaseback to purchase the next home of your dreams and move out without stress.
- Revolving debt allows a borrower to spend money, pay it back, then spend again.
- Installment debt gives borrowers a lump sum, which is repaid according to preset terms.
- There is no one debt that’s “better” per se when considering revolving debt vs installment debt. The terms of your debt depend on the purchases you wish to make.
- Investopedia. Revolving Credit vs. Installment Credit: What’s the Difference? https://www.investopedia.com/ask/answers/110614/what-are-differences-between-revolving-credit-and-installment-credit.asp
- NerdWallet. Revolving Credit vs. Installment Credit: What’s the Difference? https://www.nerdwallet.com/article/finance/revolving-credit-installment-debt-score