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Three Main Types of Credit

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The three main types of credit are installment, revolving and open. 

  • Installment credit is a loan with a fixed amount of money, fixed payments and an established repayment schedule. 
  • Revolving credit is a loan that allows you to continuously borrow money against a line of credit and pay it back with monthly payments. 
  • Open credit also allows you to continuously borrow money, but there are no interest rates and you’re required to pay your balance in full each month to avoid penalties.

It’s important to understand the different types of credit so you can confidently choose which one is best for you and make informed borrowing decisions. Appropriately using various types of credit contributes to your credit diversity (also known as your credit mix), which can help improve your credit score.

Your credit diversity is related to your overall credit health because it affects your FICO® credit score (it’s worth about 10 percent). If you’re able to handle multiple types of credit—meaning, you use them wisely and pay them back in full and on time—lenders will see you as a more responsible user. Vantage scoring uses a slightly different system, so we’ll be referencing FICO scoring in this piece for the sake of simplicity.

Installment credit entails a fixed loan amount, fixed payments and exact time frame for payment. Revolving credit allows you to continuously borrow money but with a credit limit and monthly payments. Open credit requires making a full monthly payment to avoid penalties and no interest rate.

Let’s get to covering the three main types of credit, how each affects your credit score, their pros and cons and some tips for managing your credit.

1. Installment Credit

Installment credit is distributed in a lump sum payment that you pay back over time through fixed payments on an established repayment schedule. Since installment loans come in so many different forms, you can get one from a variety of lenders. Some options to consider are banks, online lenders and credit unions.

The requirements to apply for an installment loan are a government-issued ID, proof of income, a checking account and verification of your Social Security number (specific requirements vary by state). If you have a bad credit score, installment loan lenders—if they even offer loans for bad credit—will gather information to understand your financial information before determining if you qualify.

For installment credit, interest is only paid on the original amount. Additionally, lenders see installment loans as lower risk than revolving loans, since after you pay off the debt, there’s no option to continue borrowing money—it’s more of a one-and-done process. In comparison, revolving credit can continue for as long as you need it and use it responsibly. This leads to installment credit having relatively lower interest rates.

The most common examples of installment credit include:

  • Mortgages
  • Personal loans
  • Student loans
  • Auto loans
  • Many consumer loans

How Do Installment Loans Affect Credit Score? 

The size of a loan influences how much it affects your credit score, and installment credit is a high-risk, high-reward kind of credit. Installment credit tends to involve larger sums—think mortgages and student loans—so while successfully managing installment credit is beneficial for your credit score, not making payments on time can have major consequences.

Pros: 

  • A regular payment schedule makes planning and budgeting easier.
  • You can make more expensive purchases that you otherwise wouldn’t have been able to afford.
  • Installment credit tends to have lower interest rates than revolving credit, since lenders see installment credit as lower risk.

Cons: 

  • A rigid payment schedule can be difficult to adhere to if your finances suddenly change.
  • Loan types are limited to one type of purchase (e.g., a mortgage is just for your home, an auto loan is just for your car, etc.).
  • You can’t get more installment credit without going through the application and approval process again.

2. Revolving Credit

With revolving credit, the amount of money that you can borrow replenishes as long as you keep making payments. Credit cards—the most common type of revolving credit—have credit limits, which are your maximum spending amounts. For example, if your credit limit is $1,000, you can’t borrow more than that amount at any given time. If you’re at your credit limit, you must pay off some of your debt before you can borrow more money.

Payments for revolving accounts are usually made on a monthly basis, with interest that’s either a fixed amount or a percentage of your balance. Because these payments tend to be smaller than installment credit payments, revolving credit is considered less risky for borrowers.

However, lenders see revolving credit as higher risk, since you can borrow money indefinitely. This leads to revolving credit having relatively higher interest rates than installment credit. Depending on the terms of your account, you may be able to avoid interest charges by paying off your full balance each month.

The most common types of revolving credit include:

  • Credit cards
  • Personal lines of credit
  • Home equity lines of credit (HELOCs)
Credit cards, personal lines of credit and HELOCs are common forms of revolving credit.

How Does Revolving Credit Impact Your Score? 

Though the amounts of money involved with revolving credit tend to be smaller than the amounts associated with installment credit, revolving credit still has the potential to significantly impact your credit score. 

It can be tempting to pay only the minimum amount on your credit card or carry over some expenses from month to month. However, this can increase the interest you pay on the debt. This cycle of paying your debt on top of exponentially growing interest can spiral out of control if left unchecked. Your credit utilization makes up 30 percent of your credit score, so it’s important to keep your credit card debt in check. It’s easier to maintain a manageable credit balance rather than work to overcome credit card debt

Pros: 

  • Flexible borrowing amounts adapt to your changing financial needs.
  • Replenishing credit allows you to continuously borrow without repeated approval.
  • Having the option to pay the minimum amount each month allows you to wait until you have the funds to make larger payments—good for irregular income.
  • You can borrow money for various kinds of purchases.

Cons: 

  • Since you can borrow indefinitely, it’s easy to build up a large amount of debt.
  • Revolving credit tends to have higher interest rates than installment credit, and compounding interest can rapidly build up.
  • The credit limit prevents you from financing more expensive purchases.

3. Open Credit

Open credit is the least common of the three main types of credit. Though a utilities account (gas, electric, water) is one example of open credit, it typically comes in the form of charge cards, which function like credit cards (i.e., you can make electronic purchases) but differ when it comes to payments. 

Like revolving credit, open credit is distributed in any amount that you need. However, there is no preset limit for charge cards. This might sound like you can spend an unlimited amount of money, but it actually means that you have a limit that changes based on factors like your spending patterns, income, payment history and credit score. With this changing credit limit, you’re usually able to make larger purchases than you would with a credit card.

Payments for open credit also tend to be monthly, but unlike revolving credit—where you can pay a portion of what you owe each month—you must pay your full balance each month to avoid penalties. Also unlike revolving credit, there is no interest on open credit.

Common examples of open credit include:

  • Charge cards
  • Utilities accounts (gas, electric, water)

How Does Open Credit Affect Your Score? 

Like the other types of credit, open credit will affect your payment history, the most important factor of your credit score. However, since charge cards don’t have a predetermined limit, they don’t affect your credit utilization (the ratio of your credit card balance over your total available credit), which determines 30 percent of your credit score. This makes open credit less risky than revolving credit.

Pros: 

  • Flexible borrowing amounts adapt to your changing financial needs.
  • No interest rates minimizes the cost of borrowing.
  • An adjusting limit (instead of a preset limit) allows for larger purchases.

Cons: 

  • There are steep penalties if you can’t pay your balance in full each month.
  • Open credit has less flexible payments than revolving credit, since you have to pay your full balance—you can’t just pay the minimum.
  • You typically need a high credit score to get approved for a charge card, so it’s harder to get than a credit card.

Tips for Managing Credit

There are different credit management approaches for each credit type. Managing installment credit involves paying a large sum back over time with fixed payments on an established timeline. With revolving credit, you’ll want to consistently pay back variable payments every month for an indeterminate amount of time. Your open credit balance should be paid in full every month.

Keep these basics for managing your credit in mind:

  • Make payments on time
  • Create a budget and stick to it
  • Keep track of how much you owe
  • Pay more than the minimum amount if you can
  • Avoid the temptation to spend money you don’t have

When managing your credit, take into account the different factors that determine your credit score. The five main factors of FICO credit scores (and their weight) are payment history (35 percent), amount of debt and credit utilization (30 percent), age of credit (15 percent), new accounts and inquiries (10 percent) and credit diversity (10 percent).

Having a variety of credit types can help boost your score and accounts for 10% of your FICO score.

If you want to learn more about your options for credit repair, we have a variety of credit education resources to help you learn good habits and reach your financial goals. If you’re just getting started, learn more about what a credit score is, what affects it and how you can maintain healthy finances.

Posted in Credit 101
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