Understanding the two types of debt

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.

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