Installment Credit vs Revolving Credit. June 3
There are two types of credit that you can apply for: Installment credit and Revolving Credit. In an installment credit you get a loan for pre-determined period of time at a pre-determined interest rate with pre-determined payments. A good example of an installment credit would be your home mortgage. When you apply for a mortgage the interest rate (which varies from 5% to well over 8%), the loan period (usually 15, 20 or 30 years) and the amount are pre-determined before you get the loan. And during the lifetime of the loan the interest rate, loan period and the loan payments do not change unless you refinance the loan.
On the other hand in a revolving credit the interest rate, the loan amount and payments usually vary every month. An example of a revolving credit would be your credit card. When you apply for a credit card you get a revolving credit with a maximum limit of credit and an interest anywhere between 10 and 28 percent. Every month you could borrow up to the maximum limit of credit on your credit card. Then at the end of the month you get an account statement and will have several options to pay. You could either pay the whole amount, or pay a minimum amount as specified on your account statement or pay any amount in between.
Here is where the revolving credit differs from installment credit. If you pay the whole amount on the revolving credit you loan is paid off and you will have no more payments unless you use your credit card in the future. Whereas if you only pay the minimum amount you are just paying the interest on the credit you used and your actual debt revolves to the next month. As you can see this is not really recommended as your debt keeps revolving month after month and it could take a lifetime to pay the original principal.
The other difference is that the credit card issuer can increase or decrease the credit limit at any time depending your credit report and monthly payment history. If you have been paying your bills on time then the credit card issuer might increase your credit limit allowing you to borrow more money. Likewise if you have been missing payment your credit limit might be cut down. Similarly the credit card issuer could also increase or decrease your interest rate on your credit card. The interest rate on revolving credit is usually much higher than an installment credit.
One of the biggest advantages and disadvantages of a revolving credit is the credit limit. If used responsibly it can be very beneficial as you have more buying power readily available without having to apply for a loan. Whereas many people find it hard to resist using up the entire credit limit and then apply for another credit card and do the same. Eventually they get buried in the credit card debt. So be smart and use any kind of credit responsibly.