By Chron Contributor Updated November 17, 2020
Your credit score increases if you have both revolving and installment credit accounts. Installment accounts are those you pay over time, paying a set amount each month. Revolving account payments vary by how much credit you use. By understanding the differences between these types of accounts and how the credit bureaus consider these debts, you can better manage you credit score and improve your ability to borrow at better rates.
When you open an installment account, you borrow a specific amount of money, then make set payments on the account. When you take out the loan, you know the amount of the payment and how many payments you'll need to make to pay off the account. As you make the payments, the balance of the account decreases.
Common examples of installment loans include mortgage loans, home equity loans and car loans. A student loan is also an example of an installment account. Except for student and personal loans, installment loans are often secured with some collateral, such as a house or car, explains credit card issuer, Discover.
A revolving account allows you to borrow an amount up to a specific limit. For example, if you have a credit card with a $5,000 limit, you can borrow any amount up to $5,000. The payment amount on a revolving account varies depending on how much you borrow. As with an installment account, the balance decreases as you make payments.
However, unlike an installment account, you can choose to continue borrowing against the account as you make payments. In addition to credit cards, other examples of revolving credit include home equity lines of credit and accounts with overdraft protection.
Revolving accounts have more of an impact on your credit score than installment accounts, so you might want to pay those down first if you want to raise your score, according to CNBC's financial website.
In addition to installment and revolving credit, the credit rating company Experian recognizes two other types of credit: charge cards and service credits. A charge card works like a standard credit card, except that you must pay off the account’s balance in full each month.
A service credit exists when you make an agreement with a company to pay a bill monthly. A common example of a service credit is electrical service. The electric company charges you each month for the electricity that you use and requires you to pay the bill in full.
Having a mix of installment and revolving accounts can help you build your credit score. This will help you to obtain credit and receive credit on better terms, both of which can help you to grow your business. Though the amount of payments remaining on an installment loan is a factor that credit bureaus use when setting your credit score, a bigger factor is the amount of revolving credit you're using.
By paying down your balances on revolving accounts, you can improve your credit score by lowering both your total debt as well as improving your percentage of available credit.
There are different types of installment loans, and they can be secured or unsecured. This refers to whether you need an asset, or “collateral,” that could be used to pay back the loan if you can’t. Each loan’s interest rate, repayment term, fees and penalties may be different. So whatever you’re in the market for, it’s a good idea to shop around.
Here are some of the most common types of installment loans:
Auto Loans
Auto loans can help you pay for a new or used car. An auto loan is secured by the car you buy. Auto loans usually have fixed interest rates and repayment periods that typically range from two to seven years.
Learn more about how to get a car loan.
Mortgages
A mortgage is used to buy a house and is secured by the house. There are lots of different types of mortgages. The most common are repaid over 15 to 30 years.
Learn more about different types of mortgages and the credit score you might need to buy a house.
Student Loans
Whether federal or private, student loans are unsecured and help pay for undergraduate, graduate and other forms of post-secondary education. Unlike other installment loans, you usually don’t have to start repaying a student loan straight away. Instead, you can typically wait until after you graduate and find a job.
Learn more about how to apply for a student loan.
Personal Loans
Unlike an auto loan, mortgage or student loan, a personal loan doesn’t have to be used for a particular purchase. Personal loans can be used to do things like consolidate outstanding debt, make home or car repairs, or pay an unexpected bill. Most personal loans are unsecured.
Learn more about how to get a personal loan.
Buy-Now, Pay-Later Loans
You might have come across a buy-now, pay-later loan—also known as point-of-sale financing—while shopping. Some retailers offer the option at checkout. Buy-now, pay-later loans let you spread out your payments over a few installments, instead of paying for what you purchase right away. The repayment schedule can range from a few weeks to multiple years, depending on the retailer and purchase.
Updated Mon, Aug 8 2022 11:06 AM EDT
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Having a mix of credit products in your name — such as a couple of credit card accounts and a mortgage or auto loan — helps to strengthen your overall credit profile.
These credit products fall under two main categories: revolving credit and installment credit. Lenders like to see that you have both because it shows them you can manage the many different obligations that come with borrowing all kinds of debt.
While these two kinds of credit are different, one is better than the other when it comes to improving your credit score. No matter the size of the balance, the interest rate or even the credit limit, revolving credit is much more reflective of how you manage your money than an installment loan.
Below, CNBC Select spoke to a credit score expert to understand the difference.
To maintain a good credit score, it's important to have both installment loans and revolving credit, but revolving credit tends to matter more than the other.
Installment loans (student loans, mortgages and car loans) show that you can pay back borrowed money consistently over time. Meanwhile, credit cards (revolving debt) show that you can take out varying amounts of money every month and manage your personal cash flow to pay it back.
Lenders are much more interested in your revolving credit accounts, says Jim Droske, president of Illinois Credit Services. So while you may have a large auto loan of over $20,000, lenders look much more closely at your credit cards — even if you have a very small credit limit.
"Assuming both obligations are always paid as agreed, a credit card with a $500 limit can have a greater impact on your credit scores versus a $20,000 auto loan," Droske tells CNBC Select.
It's important to pay both bills on time each month, as on-time payments make up 35% of your credit score. But only credit cards show if you'll be a reliable customer in the long run, he explains. Because your balance is constantly in-flux, credit cards demonstrate how well you plan ahead and prepare for variable expenses.
"Credit scores are predicting future behavior, so the scoring models are looking for clues of your good and bad history," Droske (who has a perfect credit score) says.
With a credit card, your balance could be under $1,000 in one month, then three times as large the next. If your history shows that you manage your money consistently enough to cover varying costs, then lenders know you're probably reliable enough to borrow more money in the future.
Having both an auto loan and a credit card in your name will impact your credit score, but the revolving credit account (your credit card) will play a bigger factor in your score's calculation. Here's why:
- Reason 1: Revolving credit is highly influential when calculating your credit utilization rate, or the percentage of your total credit that you're using. Your credit utilization is the second biggest factor (after payment history) that makes up your credit score. As you keep paying off your revolving balance on your credit card, your credit score will go up and you'll free up more of your available credit. Whereas with an installment loan, the amount you owe each month on the loan is the same, and the total balance isn't calculated into your credit utilization.
- Reason 2: Revolving credit has more of an impact on your credit score because it also offers more "financial clues" into your behavior than installment credit does, Droske says. With a $20,000 auto loan, the borrower can only behave in so many ways: Either they make the monthly payment on time over the term of the loan or they don't. On the other hand, borrowers can make lots of decisions when using a credit card — charge a little and pay the minimum, max it out and pay it off entirely, don't use it at all. How you manage your variable debt tells lenders a lot about how you'll manage future debt you don't have yet.
If you don't have any credit accounts in your name, and you want to build your credit history, it's best to start with a credit card designed for newcomers.
CNBC Select ranked the best credit cards for building credit, and the Petal® 2 "Cash Back, No Fees" Visa® Credit Card topped the list for the best starter credit card for a few reasons.
First, the Petal 2 Visa Credit Card allows applicants with no credit history to apply, and there are no fees whatsoever*. If you have a credit file, it does factor into the credit decision. It also has a rewards program meant to help you establish good credit habits: 1% cash back on eligible purchases right away, which can increase up to 1.5% cash back after you make 12 on-time monthly payments. This is a great perk that can get you in the routine of making monthly bill payments on time. Plus, Petal offers 2% to 10% cash back from select merchants.
Another card to consider is the Capital One Platinum Secured Credit Card, which has a low security deposit (learn how secured credit cards work) and the Capital One Platinum Credit Card, which is good for applicants with average credit.
At the end of the day, the most important factor is that you use your credit products to your advantage. Feel free to charge expenses on your credit card to earn points or cash back; just make sure you can pay the balance off in full by the time the bill comes. The same goes with installment loans like personal loans, car loans and mortgages.
"In the long run, always pay your installment loans on time," Droske says.
Information about the Capital One Secured and Capital One Platinum Credit Card has been collected independently by Select and has not been reviewed or provided by the issuer of the card prior to publication.
Petal 2 Visa Credit Card issued by WebBank, Member FDIC.
*The regular APR variable for the Petal® 2 "Cash Back, No Fees" Visa® Credit Card currently range from 15.24% - 29.24%
Editorial Note: Opinions, analyses, reviews or recommendations expressed in this article are those of the Select editorial staff’s alone, and have not been reviewed, approved or otherwise endorsed by any third party.