What is the difference between installment and revolving credit accounts?

Installment loans are loans extended for a specific purpose, a specific time, and a specific rate of interest. Normally the buyer signs a security agreement giving the lender the right to take back the property being purchased in the event the borrower does not pay in full.

Installment loans are used for major purchases such as homes, cars, major appliances, recreational vehicles, expensive furniture and other high value items. In the normal course of events installment loans involve monthly payments. At the end of the prescribed time the installments (payments) have been made as agreed, the loan balance is zero, and the buyer owns the property free and clear.

Video: Installment Loans and Credit Scores

Revolving credit, on the other hand, is used when there will be an ongoing cycle of borrowing and payments. Based on a number of factors including, and weighting heavily the borrower’s credit score, the lender decides the maximum amount the consumer can borrow and the rate she will need to pay. Low scores increase your rate and decrease your limit. A credit limit is set and the rate assigned. The consumer then signs a revolving credit agreement. The credit card can be used to purchase a great variety of goods and services. The card holder must make monthly payments in an amount determined by the revolving credit agreement, but which vary according to the amount currently owed and the interest rate being charged. The typical cycle involves making credit purchases, then making payments, then borrowing again, then making payments. Banks issue revolving credit cards. Even store revolving credit cards, such as Best Buy, are issued by banks (HSBC Bank Nevada for Best Buy, and Norwest Bank for Dell Computers).

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Some stores use a combination of these two methods. Dell offers a revolving credit plan for businesses which does not have a security agreement, as well as “leases” which set a fixed payment. Since one of the leases sets a $1.00 payment to purchase at the end, it is equivalent to a purchase with a security agreement.

Which type of credit is better for my credit score?

Although both types of credit can help your credit score if used responsibly, the rating agencies and lenders tend to give more weight to installment loans. Such loans show planning and follow through when the payments are made on time and continued until the entire balance is paid. Revolving credit will help your scores as long as you always make your payments on time and do not normally run a balance which is a high percentage of your credit limit. Having lots of accounts with high balances and a even a few late payments is very bad for your credit score. Installment payments always made on time and followed through until payoff are very good for your score.

How do I build credit?

If you want credit when you need it, you need to establish credit by borrowing and repaying loans. When doing so, don’t pay off things immediately. Thirty-five percent (35%) of your credit score is based on making payments on time. You don’t have to run things out the full term, but you want to show a record of dependable bill-paying. Don’t run a lot of high balances, and always pay on time. Low balances and regular payments increase your score; high balances and late payments decrease it.