Revolving Credit vs Installment Loans and Impact on Credit

Revolving credit credit vs installment loansDo you have any revolving or installment credit lines on record right now? Do you even know the difference between the two? Don’t worry if you’re confused, we’re about to clear things up. If you already have a basic understanding of how your credit score is determined, then you’re ready to move on to the more advanced stage of understanding.

What is Revolving Credit

Revolving credit is exactly as it sounds. You open a line of credit and although you have a credit limit, you can use as much or as little of that credit line as you’d like. Obviously, this sounds exactly like a credit card. In fact, credit cards are considered revolving credit. But there are other forms of revolving credit as well. A home equity line of credit (HELOC) is also an example of a revolving credit line.

Installment Loans

An installment loan is a predetermined amount of credit distributed to a borrower that is paid pack in equal amounts every month. Technically, not every installment line of credit is paid back in equal amounts each month. Financial issues can damage a borrower’s ability to pay back a loan, but in practice an installment loan is meant to be paid off in equal proportions every month. The most obvious examples of installment credit are personal loans, mortgages, student loans and car loans.

Impact on Your Credit Score

Your credit score may be a bit too perplexing for you to understand. But if you want to get your credit score into the excellent range, you’re going to need to know the impact that these two forms of credit can have on your credit history. The first and most important factor that determines your credit score is your payment history. All financial companies, including the ones servicing your credit lines, report your monthly payments to the respective credit bureaus who determine your credit score. The biggest chunk of your credit score is determined by how often you make on time payments towards your debts. Miss more than two payments and you should expect a major hit against your credit score.

The Major Difference Between the Two

But there’s an interesting difference between revolving credit and installment loans. Remember that credit utilization also plays a role in determining your credit score. Your credit utilization is your current outstanding debts owed as a percentage of your total credit limit. So if your credit limit is $10,000, and you have a balance of $2,000, your credit utilization is 20 percent. Generally, the credit scoring systems will begin shaving points off your credit score once you reach the 30 percent utilization threshold. If you have a credit card, which is a revolving type of credit, and you have a low limit but you spend too much too quickly, your credit score is going to take a major hit.

However, in the case of installment credit lines, such as a mortgage, the total size of that loan and how much you have left to pay back is not factored into your credit utilization score. Say you have taken out a mortgage of $280,000 and so far you have paid $50,000 towards it. You still have $230,000 left to pay back, or about 82 percent of the total loan. But your total credit utilization will not take into account this $230,000 if the credit line is installment based, meaning your credit utilization will not be 82 percent. Because of this, installment loans are less damaging to your credit score than revolving forms of credit. But in either case, responsible and on time payments are required to maintain a decent credit score.

Posted on January 10, 2018 by in Credit Monitoring

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