Revolving vs installment credit | Loans and debt | Financial literacy | Khan Academy

So, let's talk about two very broad categories of loans. One is installment loans, and one is revolving loans or revolving credit.

If we're talking about installment loans or installment credit, that's a situation where you're borrowing one usually large amount of money, and then you're paying it back in installments. The most common examples of this are a car loan, your student debt payment, or a mortgage.

Where you might say borrow a hundred thousand dollars, and then you're paying it down over 10, 15, or 30 years, where you're paying usually a fixed amount every year to pay down how much you borrowed plus paying the interest.

Now, the other end of the spectrum, or the other category I should say, is revolving credit or revolving loans. The one most common to or most familiar to most people is your credit card. You don't call that necessarily revolving credit, but that's what it is.

What that means is there's some limit that you can borrow that the credit card issuer says, "All right, I'll lend you up to a thousand dollars; that's your credit card limit." You can use it as long as you spend less than a thousand dollars, and then you can pay it down, and then you can use some more, etc., etc.

So let's say you have a thousand dollar credit card limit, and right now you have not borrowed or you haven't used it at all. Then you go out, you spend fifty dollars on clothing. Now you owe the credit card company, the issuer, fifty dollars, and you could borrow an extra 950 from them because you've used fifty dollars of that thousand dollars.

Now you could pay that down, and I highly recommend paying it down as quickly as possible. You could pay down that fifty dollars, and now you could borrow up to a thousand dollars.

So that's why it's called revolving; you're constantly using some of it and then paying some of it back, using some of it, paying some of it back. Other than that, that's the most common example in most people's lives.

There's also things like personal lines of credit that you might be able to get from a bank. Sometimes they'll lend you that based on the value that you have in your house, where you can borrow money and then pay it back; borrow money and pay it back up to some type of a limit.

So those are the two big categories. It's nice to have a little category knowledge in your head about how they might be different. One is usually one large lump sum purchase that you're borrowing money for, and then you're paying it back in usually fixed installments.

The other is you have some kind of a credit limit, and you can borrow and pay back, borrow and pay back, depending on what your needs are in life.