If you’re confident you know the basics of how your credit score is determined, congratulations! Now it’s time to move to the next level.
Specifically, the Nerds want you to understand how various types of accounts affect your credit. For instance, what’s the relative impact of revolving and installment loans on your score? If you’re not sure, take a look at the details below.
Revolving versus installment credit
If you’re not clear on the exact difference between revolving and installment credit accounts, defining these terms is a good place to start:
Installment credit comes in the form of a loan that you pay back in level payments every month. The amount of the loan is determined at the time you’re approved, and the sum you’ve borrowed doesn’t change over time. Examples of installment credit include mortgages and car loans.
Revolving credit is not issued in a predetermined amount. You’ll have a limit to how much you’re able to borrow, but the amount you utilize within that limit is up to you. Most revolving loans are issued as lines of credit, where the borrower makes charges, pays them off, then continues to make charges. Examples of revolving credit include credit cards and home equity lines of credit (HELOCs).
Revolving accounts have the potential to do big damage to your score
You probably know that a healthy credit report contains a varied mix of credit types; in all likelihood, you have both revolving and installment accounts open right now. This means it’s important to know that revolving credit is a powerful force in determining your credit score. In fact, it has the potential to do big damage if you’re not careful.
First and foremost, remember that any account you don’t pay on time will hurt your credit. Thirty-five percent of your score comes from your history with paying your bills by their due dates. Consequently, it should be a priority to make all your credit payments – revolving and installment – on time.
But revolving credit weighs heavily on the second-biggest portion of your credit score. (Note: we’re talking about credit cards specifically – HELOCs are treated differently by the credit bureaus.) Thirty percent of your score comes from your total amounts owed. A big variable here is your credit utilization ratio, which is the percentage of how much you owe on your cards compared with how much available credit you have.
Most credit scoring models penalize you for using more than 30% of your available credit. But in most cases, the balances on your installment loans aren’t factored into this ratio. In fact, your installment loans have a much smaller impact on this portion of your credit score.
As a result, your credit cards are incredibly powerful in determining your overall score. Not only do you have to be careful to pay your bills on time, you also need to keep a close watch on how much credit you’re utilizing. It’s worthwhile to be particularly careful about this type of revolving credit account – slipping up could have serious consequences.
Keep your credit solid, regardless of account type
No matter which type of account we’re talking about, there are certain moves you can make to be sure that your credit score stays solid. For instance:
- Pay your bills on time – We’ve said it before, but it’s worth repeating: Paying your bills by their due dates is the most important thing you can do to build and maintain good credit. Don’t neglect this important task!
- Keep debt levels low – Maintaining low balances on your cards is particularly helpful. But keeping all types of debt down makes it easier to pay your bills on time because you won’t be overextended in other areas.
- Be careful about applying for new credit – Apply for new credit sparingly. Too many recent inquiries will ding your score.
- Establish a credit history as soon as you can – As soon as you can get a credit card or other type of loan, be sure to do so. Fifteen percent of your score comes from the length of your credit history.
- Keep a good mix of accounts on your report – Having a variety of revolving and installment accounts on your credit report will help your score. Don’t shy away from credit, but be sure to use it responsibly.
The bottom line: Revolving and installment accounts both have an impact on your credit score. But a certain type of revolving credit – your credit cards – is especially influential. Take care to use them carefully to keep your score in good shape!
The term Debt Consolidation seems to have become a subject of great confusion and conflict based on the information given by the advertisements. Even the popular search engine like Wikipedia is not able to give a clear justification to the term, thus this information seems to prove inadequate when trying to solve people’s debt problems...
Interest on installment loans. Hearing, Ninety-first Congress, first session, on H.R. 255 to authorize banks, savings and loan associations, and other regulated lenders in the District of Columbia to charge or deduct interest in advance on loans to be repaid in installments. April 29, 1969
Book (U.S. Govt. Print. Off.)