The information provided on this website does not, and is not intended to, act as legal, financial or credit advice. See Lexington Law’s editorial disclosure for more information.
Not all debts are created equal, and it’s important to understand how different types of debt can affect your credit. Two of the major debt types—revolving debt and installment debt—work in different ways, and learning the nuances of each can help you manage your debt and maintain healthier credit.
Revolving debt is any debt without a set loan amount that you can keep drawing from up to a certain point. Revolving accounts have an established credit limit, but you don’t have to follow a payment schedule or pay a fixed minimum amount each month.
The most common form of revolving debt is a credit card. With revolving credit, you have an established line of credit that you can draw on as often as you need to, so long as you don’t go over your limit. Your credit limit is determined based on your income, assets and credit history.
Here are the basics of revolving debt:
Below are some benefits and drawbacks of revolving debt:
Pros:
Cons:
Some types of revolving debt are backed by your assets, while others are not. The most well-known form of revolving debt is a credit card, which is unsecured. A home equity line of credit is another form of revolving debt, which is secured by your home.
These are the most common examples of revolving debt:
A credit card allows you to use any available funds at any time, as long as you continue to make minimum payments and don’t go over your credit limit. Carrying a balance on a credit card subjects you to accruing interest rates, whereas paying in full by the due date listed on your statement allows you to avoid interest charges.
HELOC funds are commonly used by homeowners who need to cover a large expense, such as a home remodel. How much you can borrow is based on the equity of your home, which also serves as collateral. You aren’t required to pay a specific balance each month, but making payments replenishes your available credit (similar to a credit card).
The main difference between HELOCs and credit cards is that you can only access a HELOC during a defined amount of time, known as the “draw period.” It typically lasts around five to 10 years, after which the debt must be paid back during a “repayment” period and funds can no longer be withdrawn. A HELOC usually has far lower interest rates than a credit card since it’s backed by an asset (your home).
Very similar to a credit card, these are funds you can borrow as needed and repay immediately or over time. Personal lines of credit allow you to carry a balance that accrues interest as you continue to borrow. Interest rates are usually variable, so it’s tough to predict how much you’ll end up paying for what you borrow.
Lines of credit usually allow you to withdraw money in the form of a check or cash. If you need cash, a personal line of credit can be the more affordable option due to the high fees associated with credit card cash withdrawals. It’s also possible to receive a higher credit limit with a personal line.
Business lines of credit operate almost identically to personal lines of credit, except they’re used for business expenses. This type of revolving loan lets you access your funds as needed to finance continuous short-term purchases, such as inventory, equipment repair or filling in a gap in cash flow.
While revolving credit can certainly help you improve your credit, it requires careful attention to how you use it. If you have a habit of missing payments or using too much available credit, it might harm your credit more than it would help it. It’s also possible for lenders to make a mistake and inaccurately report a missed payment on a revolving debt account.
Here are some helpful questions to ask yourself if you’re thinking about building your credit with revolving debt:
Installment debt is a loan repaid through regularly scheduled payments or “installments.” Each installment payment includes the principal amount borrowed and interest, which is why they are commonly used for longer-term financing. The interest rate and repayment period can vary depending on the installment debt you use. There are different types of installment debt, each designed for specific purchases, like buying a new car or home, funding expenses associated with education or even consolidating revolving debt or making a personal purchase.
Using installment debt for big expenses can help build credit with a clear repayment schedule, though it often requires some collateral, and the payment terms are less flexible than revolving debt accounts.
Below are some benefits and drawbacks of installment debt:
Pros:
Cons:
The first and arguably most significant difference between revolving and installment debt is the payment structure. With revolving debt, like credit cards or personal lines of credit, you have some flexibility to borrow, repay and borrow again up to your credit limit.
On the other hand, installment debt like home or auto loans require fixed, regular payments over a specific period until the loan is fully repaid.
Another major difference is interest rates. Revolving debt typically carries higher interest rates, especially if your credit isn’t the best. Installment debt generally comes with lower interest rates.
It’s also worth double-checking whether or not your revolving or installment debt has variable interest. This means that the debt issuer can raise or lower your interest rates provided they give you notice as outlined in your contract.
Finally, the impact on your credit also differs between revolving and installment debt. Revolving debt affects your credit utilization ratio, a crucial factor in determining your credit score, while installment debt does not. We’ll get more into how each type of debt can affect your credit below.
Revolving debt and installment debt both impact your credit score. Having a mix of different types of credit accounts is one way to build your credit score. Successfully managing multiple kinds of credit is a good indicator to lenders that you’re a responsible borrower.
While late payments of any kind will usually negatively impact your credit, revolving debt in the form of credit cards can look riskier to lenders. This is because, unlike installment credit, there’s no personal asset—like a house or a car—attached to it that can be repossessed if you don’t pay on time.
Credit bureaus consider credit card debt to be one of the most reliable indicators of your risk as a borrower. Since lines of credit are one of the most common forms of revolving debt, it’s important to understand the ramifications it can have on your credit.
Pay attention to these factors when managing revolving debt:
Installment debt is typically considered less risky than revolving debt since it’s secured by an asset that you wouldn’t want to lose—whether that’s a new home, your car or your college tuition. It’s also considered more stable, so it has lower interest rates and less of an impact on your credit.
Here are a few ways installment debt impacts your credit:
Lexington Law Firm can help you work to address questionable negative items that might be harming your credit. Since revolving debt can significantly impact your credit, make sure you address errors on your credit report as soon as possible.
Note: Articles have only been reviewed by the indicated attorney, not written by them. The information provided on this website does not, and is not intended to, act as legal, financial or credit advice; instead, it is for general informational purposes only. Use of, and access to, this website or any of the links or resources contained within the site do not create an attorney-client or fiduciary relationship between the reader, user, or browser and website owner, authors, reviewers, contributors, contributing firms, or their respective agents or employers.
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