Posted 1 year ago (May 18, 2011 at 12:21 PM) in Common Financial Questions
Sterling Finance Company® is your resource for easy-to-understand explanations of complicated financial concepts. We are happy to explain the differences between installment credit and revolving credit and how they can help you reach your financial goals.
Installment Credit
When you think about big-ticket items that you take out loans for, ranging from homes to cars to college educations, you're thinking about installment credit. Typical installment loans are characterized by:
- A fixed loan term, expressed in months
- A fixed payment amount each month
- Can be secured or unsecured
The loan term will affect your monthly payment. You can usually lower your monthly payments by extending your loan term, but if you are able to pay more each month and are more interested in being out of debt than using your debt as a tool to build your credit, a shorter loan term with higher monthly payments may be a better fit. For more information about using debt to build your credit and the basics of credit, please visit our article about the ABC's of credit
At first, when paying a fixed amount over a long loan term, the monthly payment goes primarily to paying for the interest. Over time, as you chip away at the principal, that fixed monthly payment has less and less interest to cover, causing your principal to get paid down faster and faster, a wonderful process called amortization.
Installment credit can be secured or unsecured. A secured loan means that you and the lender have agreed to use something for collateral if you do not pay back your loan. An example is if they connect the deed to your home to the loan and if you do not meet your financial obligations, they can seize and sell your home to get their money back. An unsecured loan is based on your credit history, income, and reputation and does not include a collateral component. Due to the higher risk of an unsecured installment loan, the interest rates may not be as low as a secured loan, but they are easier to get if your credit is less than perfect.
Installment credit is often difficult to get for smaller purchases, which are generally the realm of revolving credit, which we will explain next.
Revolving Credit
When you think about credit cards and retail store cards, these are examples of revolving credit. Instead of having fixed monthly payments like installment credit, revolving credit payments go up and down each month based on how much credit you've used that month. Think of it as a flexible line of credit where you can keep borrowing and paying as opposed to installment credit loans where you borrow it all at once and then pay it. With revolving credit, you can pay off your purchases entirely and still be able to borrow anew up to your credit limit on that line of credit. What you should be aware of with revolving credit:
- Interest rates on these lines of credit tend to be higher and can vary extravagantly from one line of credit to another.
- This is the type of debt that people get themselves in the most trouble with because it is easy to get, easy to abuse, and can be difficult to pay off with higher interest rates.
Whether you are considering installment credit or revolving credit, Sterling Finance Company® is here to keep you informed. If you have any questions about the wide world of credit and loans, call or visit any of our financial professionals or learn more at our Loan Services.