Revolving credit vs. installment credit: what’s the difference?
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Having a wide variety of credit products shows lenders how you handle different types of debt, and it can even help improve your credit score. Your credit combination counts for 10% of your credit score calculation on the FICO scoring model, which lenders use to determine if you are a good borrower.
The two most common types of credit accounts are installment credit and revolving credit, and credit cards are considered revolving credit. To get the most out of both, you need to understand the terms, including your monthly payment amount and how they both appear on your credit report.
Below, CNBC Select details what you need to know about installment and revolving credit accounts, as well as the impact each has on your credit score.
1. Installment loan
Installment credit is a loan that provides a borrower with a fixed or limited amount of money over a specified period of time. This way, the borrower knows in advance the number of monthly payments, or “installments”, he will have to make and the amount of each monthly payment.
“It’s all explained,” Jim Droske, president of the Illinois Credit Services credit counseling firm, told CNBC Select. “You borrow a specific amount for the loan, and the payments, the interest rate, and the length of the term are all set.”
For example, a bank may grant you a loan for the purchase of a new car for a period of 63 months. This basically acts as a payment schedule, meaning that you would make the same monthly payment for a period of 63 months to pay off that loan and its interest. With each payment deadline you make, your balance decreases, and after 63 months your loan is repaid.
In addition to auto loans, installment loans also include student loans and mortgages. The repayment periods for these installment loans can last for months or years, depending on the terms of the loan. You can opt for smaller monthly payments by agreeing to repay the loan over a longer period, or you can make larger payments over a shorter period. The ability to choose your repayment schedule is a useful feature of an installment loan.
How does it affect your credit score: Since every loan on your credit report is included in your credit history, having an installment loan is helpful to show a variety of credit accounts and to increase the longevity of your credit history.
But it should be noted that the actual balance on your installment loan is not a big factor in your credit utilization rate, nor in the ratio of how much you owe to the amount of available credit you use. In fact, it’s okay to have a large installment loan balance in the eyes of lenders as long as the monthly payment isn’t too high for your income level. According to a VantageScore blog post (the other popular credit scoring model besides FICO), “you can easily have VantageScore credit scores well above 700, even with hundreds of thousands of dollars in debt. temperament. In fact, privileged consumers typically have between $ 100,000 and $ 105,000 in total debt. “
While this is true, it is important to consider the long-term costs of making large loans. The longer you are in debt, the more interest you will pay over time. So while it doesn’t hurt your score much, remember that you will be paying off the loan until it is paid off.
That said, it may be easier to budget for installment loans since the monthly payments are predictable. As long as you make your scheduled monthly payments for an installment loan, your credit score will improve. Payment history accounts for 35% of your FICO score calculation, so it’s important that you don’t miss a due date.
2. Revolving credit
Unlike installment credit, revolving credit gives borrowers a line of credit with no end date, and they can spend up to their assigned credit limit.
“This is an ongoing ‘indefinite’ credit obligation,” says Droske.
The greatest example of revolving credit is a credit card; the cardholder regularly charges fees, reimburses all or part of them, charges more, etc. The amount of money the borrower uses within their credit limit is up to them and there is no set monthly payment plan. The borrower has the option to pay off their balance in full each month (which we recommend) or to pay only the minimum and carry over, or “roll over”, their balance to the next month (which usually means they are accumulating interests).
How does it affect your credit score: Likewise with installment credit, it is essential that you pay your monthly bill on time to have the best credit score. And ideally, you pay off the balance every month. Revolving credit is very influential in calculating your credit utilization rate, which is the second most important factor (after payment history) that makes up your credit score.
Experts generally recommend borrowing or using less than 30% of your credit limit. As you pay off your revolving balance, your credit score will increase as you release more of your available credit.
Here’s how to avoid having to pay off revolving debt
You should aim to never have a balance on your credit card from month to month, as this will accumulate interest, which can quickly become expensive.
If you’re shopping for a new credit card, you might want to consider one with a 0% APR introductory period. Most zero interest credit cards require good or excellent credit to qualify, so be sure to check your credit score before applying.
For those with good credit, the Wells Fargo Platinum Card offers zero interest for the first 18 months on qualifying purchases and balance transfers (after, 16.49% to 24.49% variable APR). The card also comes with no annual fee.
For those with good or excellent credit who are also looking for rewards, the Chase Freedom® offers zero interest for the first 15 months on purchases (after that, 14.99% to 23.74% variable APR). The card has no annual fee, and new cardholders can earn $ 200 in cash after spending $ 500 on purchases in their first three months. Chase Freedom offers a revolving rewards program that offers 5% cash back up to $ 1,500 in combined purchases in bonus categories each quarter you activate (then 1%) and 1% cash back on all other purchases. From July to September, cash back bonus categories include Amazon.com and Whole Foods Market.
Don’t miss: Revolving credit debt drops to $ 996 billion, lowest since the Great Recession
The Wells Fargo Platinum and Chase Freedom® card information was independently collected by Select and was not reviewed or provided by the card issuer prior to posting.
Editorial note: Any opinions, analysis, criticism or recommendations expressed in this article are the sole responsibility of the editorial staff of Select and have not been reviewed, endorsed or otherwise approved by any third party.