Installment Loans vs. Revolving Credit

Installment Loans vs. Revolving Credit

All lines of credit fall into one of two categories – an installment loan or revolving credit. Neither one of them is “better” than the other. In fact, it’s actually great for your credit score to have a few lines of credit within both categories.

Credit Mix accounts for 10% of what determines your credit score, based on the FICO scoring model. By having a mix of both installment credit and revolving credit your credit portfolio becomes more diverse, and creates a better credit mix.

What is an Installment Loan?

Installment loans have a predetermined loan amount. This amount would be paid back over a set time frame, referred to as the loan “term”. These loans will come with an APR, or Annual Percentage Rate, which determines how much interest you’ll pay on the loan amount over time.

These three things along with other details will be discussed and included in the loan agreement between a creditor and a debtor. The party providing the loan is the creditor, and the person who is taking out the loan (and putting themselves in debt) is the debtor.

Types of Installment Loans

Many large purchases are typically made with installment loans. These loans all involve the borrower (debtor) taking a set amount of money from the creditor, who is usually a bank, credit union, or some other financial lending institution.

Examples of installment loans are:

  • Auto Loan
  • Home Mortgage
  • Student Loans
  • Personal Loans

You don’t necessarily have to have perfect credit to get an installment loan. In fact, there are certain lenders that specialize in helping borrowers with damaged credit. These lenders are commonly called subprime lenders, and can provide installment loans for bad credit borrowers when many traditional lenders can’t.

What is Revolving Credit?

Non-installment credit, or revolving credit accounts are a bit different than installment loans. When you take out a line of revolving credit, there is defines loan amounts or a loan terms. Instead, you’ll have a set credit limit and there is no certain end date. In the case of a credit card there will be an expiration date, but that doesn’t mean that your line of credit will be gone, just that you need to get a new card which will often be sent automatically by the creditor.

The reason that it is called “revolving” credit is because you can keep using it, paying it off, and using it again! (Just make sure you take care of the paying it off part).

Revolving credit also has an APR, and the debtor is obligated to pay interest on the charges made to the account. The key is to pay off these credit balances before your monthly due date to avoid interest fees.

There can be limitations to these lines of revolving credit depending on where you open the account and your personal preferences. For instance, your spending may be limited to a certain store or group of stores – or – it could be wide open for you to use at any store or online.

Examples of Revolving Credit

Revolving credit most often comes in the form of a credit card. However, there are many different stores and financial institutions that have revolving credit cards you can apply for.

Some examples of revolving credit include:

  • Bank or Credit Union credit cards
  • Retail store credit cards

How Do Installment Loans Affect Your Credit Score?

Installment loans, just like any other line of credit, can greatly boost your credit score and positively contribute to your credit history. Or… they can do the exact opposite if you handle them carelessly.

Installment loans will contribute to your score in payment history and credit mix. Payment history in the FICO model is the most important aspect of your credit, accounting for 35% of what determines your score. Balances of installment credit is not factored into your credit utilization (how much of your available credit you are using), which is the second most important factor coming in at 30%.

The disadvantage to installment credit in terms of how it contributes to your credit score, is that it has an end point. Once the loan is paid off, that line of credit is completed and will not contribute positive payment history any more.

That’s okay though, you probably don’t want to have a car payment, or worse a house payment, for the rest of eternity just for the sake of boosting your credit. There are better ways to raise your credit score, trust us. Half the battle is understanding how credit works and make smart financial moves that will contribute positive credit history.

How Does Revolving Credit Impact Your Credit Score?

Revolving credit affects your credit history and scores in many of the same ways that installment loans do. Solid on-time payment history will help improve your credit tremendously. It will also add another type of credit into your credit mix.

The advantage that you get with revolving credit is that it is constant. Until you close the account yourself, you’ll be adding in another factor – credit age. That’s right, just the fact that you’ve been building credit for a while helps your scores! Credit age accounts for 15% of FICO scores. So don’t be too quick to close credit accounts, because dropping the number of credit lines, and removing your older credit accounts can prove damaging to your credit score.