The three main types of credit: revolving credit, installment loans, and open credit
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Written byCFI Team
What are the Types of Credit?
The three main types of credit are revolving credit, installment, and open credit. Credit enables people to purchase goods or services using borrowed money. The lender expects to receive the payment back with extra money (called interest) after a certain amount of time.
Revolving Credit
A line of credit is one type of credit that comes with a capped limit and can be used up until you reach the predetermined threshold. It may include regular minimum payments, but usually, there is not a fixed repayment schedule. An example would be a credit card as there is a capped limit (the credit card limit), and you can keep using it until you reach such a limit (then over-limit fees apply). Another example would be a HELOC (Home Equity Line of Credit).
For more information on revolving credit, click here.
Installment
Installment loans are another type of credit that includes a fixed payment schedule for a specified duration. An example of an installment loan would be a car loan — you are required to pay a set amount of money at a recurring interval (ex. $280 per month) until the loan is paid off in full. Other examples include mortgages, student loans, and term loans.
For more information, see revolver debt versus installments.
Open Credit
Open credit is a type of credit that requires full payment for each period, such as per month. You can borrow up to a maximum amount, similar to a credit card limit, but you are required to pay the funds borrowed in full at the end of each period. An example of this would be a cellphone bill — you can make phone calls, send text messages, and use data each month, and at the end of the month, you are required to pay for the services you used (including any additional usage fees). Another example would be a utility bill (such as electricity usage in your household).
Questions
Determine which type of credit the following statements refer to.
Q1) Each month, you are required to pay $300 until the loan is paid off in full.
Q2) You are able to borrow up to $2,000 per month but must pay for all the funds borrowed each month.
Q3) You can borrow up to $1,500 per month, but you are only required to make a minimum payment (paying off the loan in full is not required).
Answers
A1) Installment
A2) Open Credit
A3) Revolving Credit
Additional Resources
CFI is the official provider of the Financial Modeling Valuation Analyst (FMVA)®. Here are some additional resources you might find interesting:
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Now, let's delve into the article on the three main types of credit: revolving credit, installment loans, and open credit.
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Revolving Credit:
- Revolving credit is a flexible type of credit with a capped limit.
- Users can borrow up to a predetermined threshold, like a credit card limit or a Home Equity Line of Credit (HELOC).
- There's typically no fixed repayment schedule, although regular minimum payments may be required.
- Over-limit fees may apply if the predefined limit is exceeded.
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Installment Loans:
- Installment loans involve a fixed payment schedule over a specified duration.
- Borrowers must make recurring payments, such as monthly payments of a set amount.
- Examples include car loans, mortgages, student loans, and term loans.
- The payment schedule continues until the loan is paid off in full.
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Open Credit:
- Open credit requires full payment for each period, often on a monthly basis.
- Users can borrow up to a maximum amount, similar to a credit card limit.
- Unlike revolving credit, the borrowed funds must be paid in full at the end of each period.
- Examples include cellphone bills and utility bills, where services are used throughout the month, and payment is due at the end.
Now, let's apply this knowledge to the questions:
Questions:
Q1) Each month, you are required to pay $300 until the loan is paid off in full.
- Answer: Installment
- This scenario describes an installment loan with a fixed monthly payment until the loan is completely repaid.
Q2) You are able to borrow up to $2,000 per month but must pay for all the funds borrowed each month.
- Answer: Open Credit
- This aligns with the characteristics of open credit, where users can borrow up to a limit but must repay the borrowed funds in full at the end of each period.
Q3) You can borrow up to $1,500 per month, but you are only required to make a minimum payment (paying off the loan in full is not required).
- Answer: Revolving Credit
- This scenario fits the profile of revolving credit, where users can borrow up to a limit and are only obligated to make minimum payments, with no requirement to pay off the entire loan immediately.
For those seeking additional resources, the article mentions that CFI is the official provider of the Financial Modeling Valuation Analyst (FMVA)®, offering free courses and finance templates. These resources cover various aspects of credit, financial modeling, and valuation analysis.
