Is a Personal Loan an Installment Loan or Revolving Credit?
Understand personal loans better. This guide clarifies the core distinctions between installment and revolving credit, helping you categorize your borrowing.
Credit represents the ability to borrow money or acquire goods and services with a promise to repay, typically with interest. It allows individuals to make significant purchases, manage unexpected expenses, or bridge financial gaps. Understanding different credit types is important for effective financial management.
Understanding Installment Loans
An installment loan provides a borrower with a fixed sum of money upfront, repaid through scheduled, equal payments over a predetermined period. These payments, known as installments, typically include both principal and interest. Once the final payment is made, the loan account is closed.
This loan type has a predictable repayment structure, simplifying budgeting. The interest rate is often fixed, keeping monthly payments consistent. Common examples include mortgages, auto loans, and student loans. Many personal loans also fall into this category.
Mortgages often have repayment periods ranging from 15 to 30 years, while auto loans typically span two to seven years. These loans are structured to provide a lump sum for a specific purpose, with a clear payoff date. Borrowers know exactly how much they owe each month and when the debt will be fully repaid.
Understanding Revolving Credit
Revolving credit offers a line of credit that can be borrowed against repeatedly, up to a pre-approved limit. Instead of receiving a single lump sum, borrowers can access funds as needed, repay them, and then re-borrow. This flexibility means there is no fixed loan term, and the account generally remains open as long as it is in good standing.
Payments are flexible, with only a minimum payment required each billing cycle based on the outstanding balance. Interest is charged on the amount borrowed, and if the balance is not paid in full, it “revolves” to the next month, incurring additional interest. As payments are made, the available credit replenishes.
Credit cards are the most common example of revolving credit. Other forms include personal lines of credit and home equity lines of credit (HELOCs). These credit types are designed for ongoing or fluctuating financial needs, offering continuous access to funds rather than a one-time disbursement.
Classifying Personal Loans
A personal loan is classified as an installment loan, not revolving credit. This classification stems directly from the inherent characteristics and structure of personal loans. When an individual takes out a personal loan, they receive a single, fixed amount of money as a lump sum.
The borrower agrees to repay this amount, plus interest, over a predetermined period through a series of fixed monthly payments. This fixed repayment schedule and the finite term of the loan align with the definition of an installment loan. Personal loans commonly have repayment terms ranging from two to seven years.
Unlike revolving credit, a personal loan’s balance does not replenish as payments are made. Once the personal loan is fully repaid, the account is closed, and a new loan application would be necessary. This clear distinction underscores why personal loans are categorized as installment debt, providing a structured borrowing and repayment experience for a specific financial need.