Is Revolving Debt Worse for Your Credit Score Than Installment Debt?

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, it’s important 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?

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 on how much you’re able to borrow, but the amount you use 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, or HELOCs.

Revolving accounts have the potential to do big damage to your score

You probably know that a healthy credit report contains a variety of credit types; in all likelihood, you have both revolving and installment accounts open right now. 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. The biggest factor determining your score is your history with paying bills by their due dates. So it should be a priority to make all your credit payments — revolving and installment — on time.

But revolving credit weighs heavily on your credit score, too. (Note: We’re talking about credit cards specifically — HELOCs are treated differently by the credit bureaus.) A significant portion 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 your available credit.

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 using. It’s worthwhile to be particularly careful about this type of revolving credit account — slipping up could have serious consequences.

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.

This article updated June 29, 2016. It originally published June 5, 2014.

from NerdWallet
https://www.nerdwallet.com/blog/finance/revolving-debt-worse-credit-score-installment-debt/