Budgeting Credit Debt

Is a Credit Card an Installment Loan?

A credit card and an installment loan are two different types of financial products. Though they both deal with borrowed money, credit cards and installment loans have differentiating repayment terms, funding amounts, and more. 

Depending on your particular situation, you may find that a credit card or installment loan has features best suited for your specific financial needs. Here, you will learn about installment loans, revolving credit, and which one may be the right choice for you. 

Installment Loans vs. Revolving Credit: What’s the Difference? 

A credit card is not an installment loan, so what is the difference? 

What Is an Installment Loan?

An installment loan, also called installment debt, is funding distributed in one lump sum and paid back over a set period of time. Installment loans also usually come with a fixed monthly payment, which can make paying off the total balance an easy and streamlined process. 

Some examples of installment loans are: 

  • Personal loan. 
  • Credit builder loan. 
  • Mortgage loan. 
  • Auto loans or car loans. 

There are also some types of installment loans that are widely considered predatory. Predatory lenders are a kind of financial institution that attempt to lure borrowers with fast funding and flexible requirements but hide hidden fees, inconvenient payback terms, and high-interest rates within the loan contracts. 

Some common predatory installment loans are:

How Is a Credit Card Different From Installment Loans?

A credit card is a form of revolving credit, also called revolving debt, which is funding available on a recurring basis and based on a credit limit. Each month a credit card holder has access to a set amount of available credit they may use however they please. Once the account holder has spent their credit limit, they will be unable to make purchases with that credit card until the billing cycle ends. After the cycle is over, the credit limit is replenished for the account holder to use again. 

Account-holders may make payments anywhere from a minimum amount (set by the credit card issuer) to the full balance to pay back a credit card balance. If possible, it is best to pay off your credit card balances in full each month to avoid accumulating charged interest. 

What Are the Interest Rates on Installment Loans vs. Revolving Credit Accounts

You may come across a couple of types of interest for installment loans or revolving credit. They are: 

  • Fixed interest.
  • Variable interest.
  • Simple interest. 
  • Compound interest. 

The most common type of interest is fixed interest. With this type of interest, your loan accumulates charges based on a flat rate, resulting in a fixed monthly payment. Most people prefer fixed interest because it makes predicting payment amounts easier. 

Variable interest means the monthly rate changes based on the current financial market. While you may save money some months with a variable interest rate, there is also the possibility that you will have to pay more some months. 

Other types of interest you may encounter are simple or compound interest. Simple interest on a loan means the rate is based on the principal amount or principal balance. Compound interest on a loan means the rate is based on the principal loan amount as well as accumulated interest from past payments. 

Advantages and Disadvantages of Revolving Accounts Like a Credit Card 

Like any financial product, a revolving credit account has advantages and disadvantages. 

Check out some perks of credit cards and revolving credit below. 

Replenished Access to Money

You essentially have constant access to money when you have a credit card. There’s no need to reapply for a loan every time you need money. If you need a bit of extra cash to get by until your next paycheck, you can make the purchases you need right away and then pay off the balance later when you get paid. 

Pay Interest Only on What You Use

When you get an installment loan, you pay interest on the entire loan amount, even if you don’t use it all. But, with a credit card, you only pay interest on the money you actually spend. This means that if your credit limit is $1,000, but you only use $100, you will only have to pay interest on the $100, not the total $1,000 limit. 

Furthermore, if you ultimately pay off that $100 balance before your next billing cycle, you may not have to pay any interest at all! You can save a significant amount on interest by paying off your credit card balance in full right away. 

Make sure you are aware of the following disadvantages and dangers that can come with credit cards. 

Credit Cards Can Lead to a Cycle of Debt

Credit card debt is one of the most common financial problems in America today. Credit cards and their replenishing credit limits make it extremely tempting for borrowers in debt to rely on their cards for everyday expenses. When you continue a habit like this, it’s easy for a credit card balance to creep up without you really noticing. 

Once a credit card balance reaches a certain amount, interest rates may cause the balance to actually go up each month, even when making the minimum monthly payments. At this point, you may need to stop using your credit card altogether until you pay off the balance. But, if you are used to relying on your credit card to get by, this may be extremely difficult or impossible to do.

Pros and Cons of Installment Credit 

Installment loans also have a few pros and cons to consider as well. 

A few pros of installment loans are below. 

Easy to Budget 

Most of the time, installment loans come with fixed interest, which means your monthly payments should all be the same. This consistency makes it easy for borrowers to keep their finances organized while they pay off their loans. 

Competitive Interest Rates

Unlike credit cards, installment loans can come with industry-wide competitive rates. Lower interest means you will pay less for the overall cost of your loan, saving you money! 

Flexible Payback Schedules

During the installment loan application process, borrowers can work with their loan agents to determine payback terms that fit their specific budget. This flexibility allows borrowers to set themselves up with affordable monthly payments they don’t have to stress over. 

Below are the cons of installment loans that all borrowers should be aware of. 

Limited Amount

With credit cards, you don’t necessarily have to worry about having enough funding. If you need more money, all you need to do is wait until the next billing cycle for a renewed credit limit. With installment credit, your one set amount is all you get. Before you apply for an installment loan, you need to consider everything you want to pay for and request a loan amount accordingly. This requires a bit more research and forethought than a revolving credit account would. 

Must Reapply if You Want More Money

If you have installment credit, like personal loans, and find that you need more money, you will have to reapply. To reapply for a loan, you will have to completely fill out another loan application, wait for approval, and then receive your funding. This process can take time and also adds another hard credit check to your credit file. Unfortunately, if you accumulate too many hard credit checks, you may start to see a significant decline in your credit score. 

How Can Credit Cards and Installment Loans Affect Credit Scores? 

Both credit cards and installment loans can have a major impact on your credit reports and credit score. A credit report is a collection of data regarding your various financial habits and behaviors. Credit bureaus collect information on the following financial categories to help determine your credit score. They are: 

  • Credit mix — What types of credit accounts you have. 
  • Payment history — How consistent you are with making on-time payments. 
  • Credit utilization — How much of your available credit you are currently using. 
  • Hard credit checks — How often you apply for new loans, credit cards, or other financial products. 
  • Length of credit history — How long you have had open and active financial accounts.

Payment history is arguably the most important financial factor contributing to your credit score. This is why staying current on installment loans or credit card payments is so important. Just one missed payment on either type of funding may result in late fees, loan default, or a declining credit score. 

What Is Credit Utilization?

Your credit utilization ratio is the comparison of how much you have available in credit with how much credit you are currently using. For example, say you had one credit card with a $5,000 limit. If you had a credit card balance of $2,500, your credit utilization ratio would be 50%. Or, if you had a credit card balance of $3,750, your credit utilization ratio would be 75%. If you completely paid off your credit card balance, your credit utilization ratio would be 0%. Since it is not exactly realistic to expect a borrower’s credit utilization ratio to be 0%, lenders typically view a credit utilization anywhere from 0% – 30% as ideal.