Have you ever asked yourself what is the difference between a revolving account and an installment account and how does each affect your credit? Well you're not alone I've had many clients as well as friends and family ask me this very question. First, you'll need to know what makes an account revolving and what makes an account installment.
Revolving credit is credit extended to you in the form of a major credit card, department store credit card, and even Home Equity Lines of Credit. The creditor will set a maximum spending amount that you can charge on this card and each month you will be assessed a minimum payment based on your current balance due. Your interest rate will be determined ahead of time, usually when you initially apply for the card. However, most contracts have written in the fine print that the interest rate can change depending on how you pay your credit card. The instances that will usually cause your interest rate to rise are if you pay the account late, go over your maximum amount of credit available, or if you pay other accounts on your credit report late. Creditors will know if you've paid other accounts late because your signing of the application for credit authorizes them to take a peak at your report from time to time. One important thing to keep in mind regarding revolving credit is that almost every account has a monthly and/or annual fee assessed. This makes your balance rise as each fee is applied directly to the balance of your account.
Installment credit is a fixed term amount and fixed monthly payment. Examples of an installment account would be a student loan, an auto loan or a home loan. The best way to determine if your account is revolving or installment is to think to yourself, "Can the balance rise?" If the answer is no, your account is most likely an installment loan. Like revolving credit, your payment history will be reflected each month on your credit report. That includes on time payment and late payments. Defaulted loans on car loans, student loans or foreclosures or short sales will remain on your credit report for 7 to 10 years. Keep reading to see how you can increase your credit score using both revolving and installment loans.
The key to keeping your credit score high is to have a healthy mix of both revolving and installment loans. The ratios should be 30-40% revolving credit and 60-70% installment. The experts say when you have a revolving account, i.e. credit card that you should use to buy only what you can afford in the short term. For example, buy your groceries with your credit card and then go home and make a payment for that exact amount on your account. Or fill up your gas tank using a credit card, then at the end of the month pay your credit card down to zero balance.
You have many different options for building up your credit with installment accounts. If you have a student loan or an auto loan, as we mentioned above, then you are already building up your credit so long as you're making payments on time. If you are in the market for a home- a mortgage paid diligently and reliably will do wonders for your credit. If these options aren't right for you then consider obtaining a small personal loan or secured loan from your bank or credit union. Go for something short-term of which you will be able to make the payments. Remember, the whole point is to prove to the credit bureaus that you can handle credit responsibly.
Topics to come:
Old vs. new loans
Judgments, Bankruptcy and Tax Liens- not the end of the world
Secured loans- what are they and why do you need them?