Before credit cards came along, practically all loans were installment loans granted on fixed interest payments. But fixed interest payment loans are not nearly as convenient as credit cards. With installment loans, every time you want to make a new purchase, you have to reapply for a new loan and get approved all over again. Credit cards allow you to borrow whenever you want as long as your debt stays below a certain dollar amount. Each method of borrowing has advantages and disadvantages.
The majority of credit cards will charge a variable rate on your outstanding revolving balance. A variable rate means the interest rate you pay the credit card issuer on your debt will fluctuate as market interest rates change. You will pay a certain number of percentage points over what it costs the credit card company to borrow the money it lends you. The credit card company also will penalize you with an even higher rate if you ever miss a payment. Payments for fixed interest rate loans, however, do not change during the life of the loan. Examples of fixed interest rate loans are mortgages, automobile loans and loans from credit unions.
Credit cards have revolving balances, which means you do not have to pay the full balance at the end of the month. You make a small payment and are charged interest on the unpaid balance. As you pay down the balance, you are free to keep borrowing, which means you could keep an indefinite loan balance with a credit card company. But fixed interest loan payments usually have a definite ending date for a specific amount of money you are borrowing. You know in advance how much your monthly payments will be and how long it will take to pay off the debt. For instance, car loans for three years will have 36 payments at a fixed rate. A 15-year home mortgage will be scheduled for 180 payments at a fixed rate of interest.
Credit card interest rates are typically much higher than the rates charged for fixed interest loans. It is not uncommon for credit card companies to charge interest rates that exceed 20 percent. Fixed interest rate loans for automobiles and mortgages are usually less than 10 percent even for people with imperfect credit histories.
While interest rate and loan payments are steady with an installment loan, the amortization schedule earmarks a greater portion of your payments to interest rather than principal at the beginning of the loan life. Over time, more of your payments will be applied to reducing the principal debt. Credit card debt also is paid down through amortization. The only difference is that borrowers are allowed to keep adding debt to the balance as they pay it down, which can make it more difficult to project when the balance will be paid to zero.
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