Sometimes expenses pop up and you need help making ends meet. You’re considering a personal loan, and you want to learn more about them. So you do your research. You explore different lenders. But you still have this question:
Is a personal loan installment or revolving credit?
Before you borrow, it’s important to understand exactly how the type of loan will work. Because there’s a big difference between installment loans and revolving credit. And a personal loan is one and not the other. Here’s what you need to know.
Is a personal loan installment credit or revolving credit?
A personal loan is one of the most common types of installment credit. This means that the loan is paid back in “installments” over a regularly scheduled period of time. Installment loans may also be known as “term loans” because the period of time in which they are repaid is known as the “term.” Other types of term loans include mortgages and student loans.
Revolving credit, on the other hand, is a form of credit that replenishes as you repay. You can then borrow from that amount as needed without having to reapply. Popular types of revolving credit include credit cards and personal lines of credit. Some types of lines of credit can be used for personal expenses, but the term “personal loan” is usually reserved for short-term installment loans.
What can a personal loan be used for?
As the name would suggest, personal loans are used to cover personal expenses. Some of those may include things such as:
- Regular expenses like groceries, bills, rent or a mortgage.
- Emergency expenses like a car or home repair bill.
- Annual expenses such as school fees or holiday gifts.
- Larger loan amounts may be used for debt consolidation or health care expenses.
Personal loans should not be used as student loans, auto loans or for investments.
What is an installment loan?
With an installment (or “term”) loan, a borrower is approved for a lump sum of money and then repays it with interest over a specified period of time. This period is known as the “loan term” and requires payments be made in “installments” on a regular schedule — most often as fixed payments once a month. On each monthly payment’s due date, the borrower can either pay the regularly due fixed amount or more. The length of the repayment period typically depends on the amount of money borrowed and the borrower’s credit history.
The rates and terms for an installment loan will primarily depend on the lender and the borrower’s creditworthiness. Before you borrow, make sure to understand both how an installment works and what specific rates and terms the lender is offering.
What is revolving credit?
Revolving credit is a type of personal funding that replenishes as you repay. Examples of revolving credit include credit cards and lines of credit.
With a line of credit, a lender approves you for a credit limit up to a certain amount of money. From that available credit amount, you are able to withdraw funds. The funds are then sent to your bank account, from which they can be used as cash. As you repay the borrowed money, the funds become available to draw from again.
What is a home equity line of credit?
A home equity line of credit is another type of revolving credit account. With a home equity line of credit, otherwise known as a HELOC, the money the borrower has put into their home (their equity) serves as collateral to secure the funding. That means that you could potentially lose the equity you’ve put into your home (or even the home itself) if you are unable to repay.
Home equity loans are similar to HELOCs in that they are a personal loan that uses your home’s equity to secure the loan. Because people who take out a home equity loan also have to concurrently pay their mortgage, these loans are sometimes also referred to as a “second mortgage.”
What do lenders consider when you apply for a personal loan?
Credit scoring models may consider the following factors when you apply for a personal installment loan:
- Your personal FICO® credit score and history.
- Total amount of outstanding debts in your credit mix.
- Sometimes your bank account transactions, depending on the lender.
What specifically the lender will consider when you apply for a personal loan also depends on whether they do a “hard” or “soft” credit pull. Some lenders will advertise that they provide “no credit check” loans. The truth is, most lenders will do some type of credit check or at least verify your income and identity before making a decision. What is usually meant with “no credit check” is that a soft pull credit inquiry is made, which will not affect your credit score.
How can I improve my credit score for a personal loan?
Having a good credit score makes it more likely that you’ll qualify for lower interest rates. With a bad credit score, you’ll be stuck with higher interest rates — or may not qualify for funding at all.
To improve your credit score, it’s critical that you make on-time payments. Your payment history is the most important factor on your credit report. The next most important factor is your credit utilization ratio. You want to try to keep your outstanding debt below 30% of your available credit.
Is a personal installment loan better than a payday loan?
Payday loans come with borrowing risks that installment loans do no. However, whether an installment loan is better than a payday loan depends on the borrower’s individual situation and what they’ve qualified for. Generally, a payday loan has a very short repayment period. They are commonly designed to be repaid upon the borrower’s next payday — or within a month or two. This can make payday loans difficult to repay, forcing borrowers to roll them over, which extends the borrowing period and increases the overall interest a borrower will pay.
Installment loans, on the other hand, come with longer repayment terms. Payments are made in small chunks that can better fit a borrower’s budget. The interest rate for a personal installment loan will largely depend on the borrower’s creditworthiness, and borrowers with low credit scores may pay high interest rates for bad credit loans. Sometimes, an installment loan with a lower interest rate can cost more in total interest than a payday loan because you pay interest for a longer amount of time.
