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Two of the main types of credit accounts are installment and revolving. Understanding the key differences between revolving credit vs. installment credit can help you manage your cash flow and avoid unnecessary interest and fees.
An installment account is what you might imagine a typical loan to be. A mortgage, auto loan or personal loan are examples of installment loans. These usually have fixed payments and a designated end date. A revolving credit account, like a credit card, can be used continuously from month to month with no predetermined payback schedule.
It’s important to learn how these different types of accounts work so you know how they can impact your credit. Here’s more to consider as you weigh revolving credit vs. installment credit:
What is an installment account?
When you take on an installment loan, you’re usually agreeing to pay back a specific amount of money over a specific period of time. You’ll make consistent monthly payments based on the principal balance and loan interest rate. The principal balance is how much you originally borrowed. The amount you owe – in interest overall and each payment period – will vary based on the type of loan, payback schedule and interest rate. For example, many mortgages have 15- or 30-year terms. Car loans often have terms ranging from two to seven years.
The payment you make to the lender each month on an installment loan includes both interest and principal. Unless the terms of the loan change, you’ll generally pay the same amount each month. At the beginning of your payment schedule, more of your monthly payment will go toward interest. Over time, the amount of interest you pay decreases. More of your monthly payment goes toward the principal balance. You can see how it works with this mortgage loan calculator tool.
What is a revolving account?
A revolving account like a credit card or home equity line of credit (HELOC) differs from an installment loan. A revolving account gives you access to an always available credit line, which determines how much you can charge to that account at any given time. How much you owe and whether you owe interest each month depends on how quickly you pay off what you’ve charged.
You’ll be given a due date each month. If you’ve paid off your balance before the payment due date, you may not have to make a payment. If you do have a balance, this requires a minimum payment, though the minimum payment may be less than the full balance.
Typically, if you carry a balance from one month to the next, you may owe interest. You can use revolving credit as needed, which gives you flexibility. But flexibility can come at a price if you don’t pay your balance in full each month. Interest rates on revolving accounts may be higher than installment loans.
Building a healthy credit history
Practicing smart credit habits, like making payments on time for all your accounts, and maintaining low balances on your revolving accounts, is an important part of building a healthy credit history. For both installment and revolving accounts, your credit score can play an important part in lending decisions and the interest rate of your loan.