There are two main types of credit, or money that creditors lend to borrowers: revolving credit and installment credit. It is important for consumers to understand the differences between revolving and installment accounts because utilizing credit is crucial in today’s financial environment.
Furthermore, in order to build up one’s credit, it is imperative to delve into both varieties of credit to prove your ‘creditworthiness’. You must slowly but surely prove that you can use credit responsibly so that new credit will be extended to you in the future as the need arises.
Following is your guide to the two basic types of credit with which you should be familiar, as well as tips to help you build your credit through with both revolving and installment credit.
Revolving accounts are based off of a maximum credit limit from which you may borrow. You may make any charges you wish against that limit, so long as you repay. Revolving credit is considered a line of credit that is replenished to its maximum amount when you pay it off. You do not need to obtain another loan when you need money at a later date – rather, you simply draw again from your line.
The most common examples of revolving accounts are credit cards, including all different varieties. Home equity lines of credit are another common example.
Revolving credit is very open-ended in comparison to installment credit, and can basically be whatever you make of it. Unfortunately for this reason, it is fairly easy for individuals to find themselves in difficult debt situations by getting carried away with revolving accounts.
Monthly payments that are required on revolving accounts generally are much lower than installment account payments. This is because rather than owing one’s balance each month, only a small percentage of the balance accounts for minimum monthly payments.
While this might sound good initially, in reality you definitely should pay off as much as of your balance as possible, whenever you can. Revolving credit interest rates usually are about 10-20%, so avoid accruing any unnecessary interest.
Revolving accounts are best used to fund inexpensive, and/or fairly temporary items.
Building Credit with Revolving Accounts
Utilizing a credit card is one of the best ways for you to start building your credit from the revolving side. Most people are able to obtain unsecured, traditional credit cards regardless of whether they have built up their credit histories. Many cards have very attractive introductory interest rates, which are great as long as you can pay off any balance you may have incurred before the rates rise.
If getting an unsecured card is not possible, then you almost certainly can obtain a secured credit card. A secured card protects your lender against the risk of lending to you by requiring a down payment from you before credit is extended.
You also might wish to obtain one or two store cards, such as a card from American Eagle or Sears. Such revolving accounts can be used only at specific chains of stores. Therefore they do not have as large of an impact on your credit as other cards, but they do help and are relatively easy to obtain.
Using any type of revolving account to help build your credit works best when you use your credit regularly but lightly. At any given time, you should not charge up more than 30% of your credit limit, because anything past this point will not affect your score positively.
Installment credit entails the lending of one lump-sum that is paid back gradually through periodic payments by the borrower. It does not replenish itself like a revolving account, so one would have to take out a separate loan if more money is needed in the future.
Installment accounts may be either unsecured (not requiring any personal property be used as collateral) or secured (secured against collateral). Common installment credits include mortgages, auto loans, personal loans, and student loans.
Whereas revolving credit sometimes makes it difficult to plan ahead for your monthly costs, monthly payments under installment agreements are specified ahead of time. This makes it much easier to plan a budget and stuck to it. In addition, installment accounts have very competitive interest rates – generally much better than revolving accounts.
Payments under an installment agreement generally are made up of interest debt in large part at the beginning on the loan. However, payments will change gradually over time so that you are paying less and less interest and increasingly more off of your principal.
Installment credit generally should be used instead of revolving credit to fund expensive, big-ticket items.
Building Credit with Installment Accounts
You have many different options for building up your credit with installment accounts. If you are in the market for a home or auto, then a mortgage or auto loan is a great choice to establish your credit. If you are looking for a much smaller commitment, on the other hand, then there are other alternatives to consider.
If you have student loans, then you already are paying on an installment account. Make these payments diligently and reliably, and it will do wonders for your credit.
If the above options are not a good match 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 that you can handle credit.