There are two types of debt—instalment and revolving. Each has advantages and disadvantages.
Instalment debt
Instalment debt is a specific amount of money borrowed for a specific purpose and repaid over a set period of time. Personal loans, car loans and leases, and mortgages are examples of instalment debt.
Revolving debt
Revolving debt establishes a credit limit and the funds may be used and repaid over and over again. Examples of revolving debt include lines of credit, credit cards, retail cards/accounts and overdraft protection.
The chart below outlines some of the major features of instalment and revolving debt. Please note that this is a general overview—every type of credit has its own features, terms and interest rates.
Instalment debt | Revolving debt | |
---|---|---|
Terms | Terms are set at the time the money is borrowed. The loan amount is set and there is a scheduled payment plan. | A credit limit is set and money can be borrowed up to that limit, repaid, and borrowed again. |
Interest | Interest rates may be variable or fixed. The interest is set for the term of the loan and is paid back in instalments, along with the principal. | Interest is charged on the outstanding balance each month. Rates tend to be higher than those on loans and mortgages. |
Payment Structure | Payments are a combination of principal and interest, which ensures the principal amount borrowed is paid down. | A minimum payment is generally required, with the interest being paid first. The minimum payment is usually a percentage of the outstanding balance. |
Payment amount | Payment amounts are usually set for the term of the loan. | Payment amounts vary from month to month. |
Prepayment options | Some loans allow for prepayment of the borrowed amount without penalty. Some closed mortgages may have restrictions on the amount that can be prepaid. | The borrowed money may be paid in full at any time. |