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Most Americans carry a combination of revolving and installment debt during their financial lifetimes. The journey often starts with a revolving credit card, but it doesn’t end there.
The ubiquitous nature of credit cards is hard to understate. According to Bankrate’s Credit Card Debt Survey data, 50 percent of Americans with a credit card carry a credit card balance from month to month. Student loans, meanwhile, are typically the first exposure you’ll get to a type of installment loan.
As you enter the workforce you’ll face financial decisions that may involve weighing the pros and cons of these two types of credit. Knowing how to use — and not use them — can have a major impact on your financial present and future.
Pros and cons of installment loans vs. revolving credit
Revolving and installment loans have very distinct advantages and disadvantages that can help or hinder your financial success. Having a mix of both types can boost your credit scores as long as you use them as part of a long-term wealth-building plan.
Installment loans
Pros
- Fixed rates and predictable payments
- Definite payoff date
- Flexible repayment terms from one to 30 years
- Low rates for excellent credit
- Can improve credit scores if used to pay off revolving debt
Cons
- No payment flexibility
- Credit is not reusable
- Fees may be high
- Approval may be more difficult for secured options
- Risk of asset loss for secured options
Revolving credit
Pros
- Credit is reusable
- Payment is based only on amount used
- Flexible payment options
- Easy approval process
- Can help build credit
Cons
- Variable rates
- No set repayment date
- Misuse can severely damage credit scores
- May charge ongoing fees or closeout fees
- Higher interest rates
Installment credit vs. revolving credit: Which is better?
With so many financial decisions to make between revolving and installment credit, it may be hard to know which to choose. In most cases, it comes down to how good your credit is, what monthly payment you can afford, how fast you want to pay it off and how fast you need funds.
When does installment credit make sense?
There are some very specific ways an installment loan can help you accomplish a larger financial goal or clean up a financial mess — especially if you can get an installment loan with a low interest rate.
- Pay off revolving debt to improve your score: Besides payment history, how much available credit you’re using has the most significant impact on credit scores. A personal loan for debt consolidation can be a great starting step toward a higher credit score future.
- Avoid new revolving debt: An installment loan forces you to commit to a set repayment schedule. Seeing what the payment looks like with a set payoff date may be a good deterrent to impulse credit card use.
- Get a fixed rate and stable payment: If you want the stability of a regular payment to cover an expense, an installment loan is your best bet.
- You have stable income and employment: Because an installment loan is fixed, the lender will want to confirm you have a regular, consistent income history.
Some examples of good ways to put installment loan funds to work include:
| Good installment loan uses | How it’s good for your finances |
|---|---|
| Clear out revolving credit balances | Reduces your credit utilization ratio, which could significantly boost your credit score |
| Reduce your monthly expenses to put money toward other financial goals | With terms as long as 30 years, you could seriously reduce your monthly payment to put more toward savings or retirement |
| Sets a date toward your debt freedom goals | You pick a repayment term consistent with your debt payoff goals |
| Debt off motivator | Because there’s no minimum payment option, and the debt can’t be reused as you pay it off, you can’t carry a balance |
| Acquire important assets | You can spread the payments over several years or decades to build wealth in assets like homes, cars or even business inventory. |
When should you choose revolving credit?
Revolving credit can be a great tool for building credit. When used carefully, it can help you establish a solid credit history or spread out payments on expenses for an ongoing business venture or home improvement.
| Good revolving credit uses | How it’s good for your finances |
|---|---|
| Build a credit repayment history | If you’re a recent high school student or new to the U.S., a credit card can put you on the credit scoring map for future credit needs. |
| Cover ongoing home improvement expenses | If you’re planning a series of upgrades or improvements, you can just use the amount of credit needed rather than the whole balance |
| Add a cushion for a seasonal business | Fund expenses for a lawn care business in the spring and summer or an online business inventory purchases without depleting your cash |
| Build savings or get rewards for special life events | Add cash back reward savings to your overall savings budget and reduce the cost of major expenses like family vacations. |
Bottom line
Whether you choose revolving or installment debt, it should be part of a larger financial plan that reduces or eliminates debt. Every dollar of interest you pay on credit is money that could be working for you in a high-yield savings account, investment portfolio or 401(k). It’s always better to earn interest than pay it.
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