Revolving debt and installment loans allow you to borrow, but they work differently. Here are some of the main differences.
Before borrowing money, it’s important to understand exactly how your debt will work, and one of the first things you need to know is if the debt is revolving or if it is an installment loan. .
Installment loans are loans of a fixed amount that are repaid according to a set schedule. In contrast, with revolving debt, you are allowed to borrow up to a certain amount, but you can borrow as little or as much as you want until you reach your limit. As you pay it back, you can borrow more.
Let’s take a closer look at installment loans and revolving debt to better understand the main differences between them.
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How Revolving Debt Borrowing Works Versus Installment Loans
Installment loans can have fixed interest rates, which means you know exactly how much interest you will be paying per month and in total. They can also have variable rates. If you opt for a variable rate installment loan, your interest rate is tied to a financial index (such as the prime rate) and may fluctuate. While the amount of your payment can change with a variable rate loan, your repayment schedule is always fixed – your payment amount simply increases or decreases as your interest rate changes, allowing you to repay the loan on time.
Most installment loans are paid monthly. You’ll know right off the bat exactly when your debt will be paid off, and if it’s a fixed rate loan, you’ll also know the total cost of the loan. These loans are very predictable, there are no surprises.
Revolving debt works differently. Common examples of revolving debt include home equity lines of credit and credit cards. With revolving debt, you have a maximum borrowing limit, but you can choose to use only a small portion of your line of credit, if you wish. If you have a $ 10,000 home equity line of credit, for example, you could initially borrow only $ 1,000. As you repay that $ 1,000, the credit would become available again.
Some revolving debt is indefinite, which means your line of credit can be left open indefinitely and you can borrow and pay off your debt forever. This is the case with credit cards. In some cases, your line of credit may only be available for a limited time, such as 10 years for a home equity line of credit.
With revolving debt, you don’t know in advance what the total cost of the loan will be, or when you’ll pay off your debt. That’s because you could borrow and pay off your loan and borrow and pay off your loan over and over again while your line of credit is open, with your payment and interest charges reset each time based on the amount borrowed. In many cases, revolving debt also charges a variable interest rate, which means that interest charges can change over time.
When can you access the funds borrowed on revolving debt versus installment loans?
When you take out an installment loan, you get the full amount you borrow all at once when you close the loan. If you took out a personal loan of $ 10,000, you would have $ 10,000 deposited into your bank account, or get a check for $ 10,000. If you decide that you need to borrow more money, you will be out of luck, even if you have paid off almost all of your $ 10,000 balance. You will need to apply for a new loan to borrow more.
With revolving debt, you can choose when to borrow funds. You can borrow right after opening a credit card, wait six months, or wait years to borrow, depending on what you want (although if you don’t use your card for too long, it could be closed for inactivity). As long as you haven’t used your entire line of credit, you also have the flexibility to borrow again and again, especially as you pay off what you’ve already borrowed.
Installment loans tend to be best when you want to borrow to cover a fixed cost, like a car or other big purchase. If you know you’ll need to borrow but it’s hard to predict when you’ll need the money or how much you’ll need, then revolving debt may make more sense.
How Revolving Debt Repayment Works Versus Installment Loans
Installment loans have a predictable repayment schedule. You agree upfront with your lender how often and how much you will pay. If you have a fixed rate loan, your payment never changes. So if you borrowed money for five years and your monthly payments started at $ 150 per month, in five years it would still be $ 150 per month.
Revolving debt payments depend on the amount you borrow. If you haven’t drawn on your line of credit, you won’t pay anything. Usually, when you have borrowed, you pay off your revolving debt on a monthly basis. But, you can only pay a small portion of what is owed. When you have a credit card, for example, your minimum payment might be 2% of your balance or $ 10, whichever is lower.
If you make minimum payments only on revolving debt, paying off what you owe can take a long time, and you’ll pay a ton of interest over the life of the debt.
Now you know the difference between a revolving debt and an installment loan
Now you know the main differences between revolving debt and installment loans, including:
- How the loan works: With installment loans, you are allowed to borrow a fixed amount and cannot access more money unless you apply for a new loan. With revolving debt, you have a maximum credit limit and can borrow as much or as little as you want. You can also borrow more by paying off what you’ve already borrowed.
- When you access the funds: If you take out an installment loan, you get the full amount you borrowed up front. With revolving debt, you actually don’t borrow anything when you have a line of credit. You can borrow at any time as long as the line of credit remains active.
- How the refund works: Installment loans have a set repayment schedule and a set repayment date. Your monthly payments are calculated so that you repay the loan on the appointed date. With revolving credit, you can make minimum payments as you borrow. And, because you can borrow more when you pay off what you already owe, there may not be a specific date when you will be released from debt.
You will need to decide what type of financing is right for your specific situation in order to get a loan or line of credit that is right for you.