Installment Credit vs Revolving Credit
Installment credit and revolving credit can have a huge impact on your credit score. But what’s the difference between them? That’s the topic we’ll tackle on the blog today. For now, we’ll say a healthy credit report contains both. And each has the potential to significantly impact your credit score. Let’s look at how it works and the installment credit vs revolving credit differences.
What Is Installment Credit?
Installment credit is a loan, usually with interest. You pay it back on a fixed schedule in monthly installments. When you receive your loan, you’re approved for a certain amount. That amount doesn’t change. The most common examples are mortgages, along with student and auto loans.
What Is Revolving Credit?
In this case, there’s no predetermined amount. You have a limit on what you can borrow, but you can work within that limit as you choose. These are lines of credit with no deadline on which you must pay-in-full. In fact, you only have to make the minimum payment each month. Essentially, you make charges, pay those charges off, and then make more charges. It revolves. The most common example of revolving credit is a credit card.
How Do Installment and Revolving Credit Impact Your Score?
Credit utilization is an important factor when it comes to determining your credit score. Your credit utilization is the percentage of your total credit line that you’re using. It’s what you owe vs. what’s available to you.
For most people, credit card loans are common. Consequently, revolving credit will have a continuous impact on your credit score. If you have a credit history that you handled responsibly, your credit score will be positively impacted. The longer the credit history, the better.
However, if you take out too many loans in a short period of time it will reflect negatively on your credit score. The same is true if you are unable to repay your debt on a regular basis. So, in the whole installment credit vs revolving credit debate on the impact on your credit score, revolving credit is more influential, but only because you use it regularly.
You want to aim for using about 30% or less of your available credit. Beyond that, most credit scoring models will penalize you. So, if you’re using more or all of your available credit, you can definitely harm your score. If you keep those revolving balances down, you’ll reap the benefits on your credit report.
All in all, maxing out your credit card will probably have more of a negative impact on your credit score than carrying a hefty balance on your installment loan.
Here at White, Jacobs & Associates (WJA), we actually coach our clients. We increase credit scores by leveraging credit resources to add positive trade-lines. It’s all part of our aggressive approach to credit repair.
Is Revolving or Installment Credit Better?
The issue of installment credit vs revolving credit, and which one is better, has no simple answer. You would need to be more specific and ask for what purpose? Installment loans are usually bigger, but they are also riskier. They come with interest on a larger amount, so you will ultimately be paying more. Yet, if they help you buy real estate, then that can make them worth it.
The worst-case scenario is that your home or car gets repossessed due to you not paying off your installment credit debt. In such a scenario, not only would you lose your possession, but your credit score would be devastated. However, installment credit can allow you to make large purchases, and regular payment will improve your credit score.
On the other hand, revolving credit entails a smaller amount of money and consequently lower risk, but a higher interest rate. Even if you get into financial trouble, you are more likely to pay off a credit card debt than a loan for a house. Because you use it for regular purchases, paying off your revolving credit debt will show lenders that you are reliable, which will positively impact your credit score.
One clear benefit that resolving credit has over installment credit is that you can pay your debt in full, whenever you are able to. Installment credit payments are fixed, which means that you are settled with the debt for the duration of the contract.
Once more we reiterate – the installment credit vs revolving credit question has no clear cut answer. The former is riskier but allows for large purchases, while the latter is more limited but can’t have such a monumental impact on your living situation. Your primary focus should be on what you need it for and whether you can pay it off.
Which Debt Should You Tackle First?
Ultimately, it’s up to you. Now that you understand the different types of credit, you’ll be better equipped to make the decision. If your aim is debt freedom, then make time to study the financial pros and cons of paying off one type of credit over the other.
Typically, revolving debt carries more weight when it comes to credit score calculations. If you want to improve your credit score, focus on paying these lines of credit off. Think about the risks involved here for a minute. There’s no collateral like a home or vehicle attached to the loan. A potential lender sees revolving debt and considers those risks.
As you make your decision about which to pay off first, consider the following:
- Your credit score
If you need to improve your credit score, get the revolving debt under control.
- Interest rates
Credit card companies usually have higher interest rates than those installment loans.
- Tax benefits
With many installment loans, you’re eligible for a tax benefit. Interest deductions aren’t possible with credit card debt.
Payment History Is Huge
No matter what, make your monthly payments. Sure, you can focus on putting forth extra funds toward a line of revolving credit. Or you might opt to pay back your installment credit. Whatever you do, pay your minimum. Don’t miss it. Without a doubt, payment history is the biggest factor in determining your credit score.
Try to put yourself into the position of a lender, and take the emotion out of it. Would you give a loan to a person who has responsibly been managing different types of credit for years, or one who has just started maxing out multiple credit cards?