Revolving vs. Installment Loan: Which Should You Have?

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Having a mix of credit products on your behalf – like a couple of credit card accounts and a mortgage or car loan – will help boost your overall credit profile.

These loan products fall into two main categories: revolving loans and installment loans. Lenders like to see you have both because it shows them you can face the many different obligations that come with taking on all types of debt.

While these two types of credit are different, one is better than the other when it comes to improving your credit score. Regardless of the size of the balance, the interest rate, or even the credit limit, a revolving loan reflects a lot more of how you manage your money than an installment loan.

Below, CNBC Select spoke to a credit rating professional to understand the difference.

Revolving Loan vs. Installment Loan: Which One Should You Have?

To maintain good credit, it is important to have both installment loans and revolving loans, but revolving loans are usually more important than the others.

Installment loans (student loans, mortgages, and auto loans) show that you can consistently repay the money borrowed over time. Credit cards (revolving debt) show that you can withdraw different amounts of money each month and manage your personal cash flow to repay it.

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 car loan of over $ 20,000, lenders take a much closer look 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 creditworthiness than a $ 20,000 car loan,” Droske told CNBC Select.

It’s important to pay both bills on time each month, as on-time payments represent 35% of your creditworthiness. But only credit cards show whether you are a reliable customer in the long run, he explains. With your balance in constant flux, credit cards show how well you plan ahead and prepare for variable expenses.

“Credit scores predict future behavior, so the scoring models look for clues about your good and bad history,” says Droske (who has a perfect credit score).

With a credit card, your balance could be less than $ 1,000 one month and three times as much the next month. If your history shows that you are managing your money consistently enough to cover various costs, lenders know that you are likely reliable enough to borrow more money in the future.

Why a $ 500 credit limit will have a bigger impact on your credit score

Having both a car loan and a credit card on your behalf will affect your credit score, but the revolving credit account (your credit card) will play a bigger role in calculating your score. Here’s why:

  • Reason 1: Revolving loans have a huge impact on the calculation of your loan utilization rate or the percentage of your total loan that you use. Your credit utilization is the second largest factor (after payment history) that determines your creditworthiness. As you continue to pay off your revolving balance on your credit card, your credit score will increase and you will free up more of your available balance. While with an installment loan, the amount you owe for the loan each month is the same and the total balance is not included in your loan utilization.
  • Reason 2: Revolving loans have a bigger impact on your credit score because they also provide more “financial clues” of your behavior than installment loans, says Droske. With a $ 20,000 car loan, the borrower can only behave in so many ways: Either they make the monthly payment on time for the term of the loan or they don’t. On the flip side, borrowers can make a lot of decisions when using a credit card – top up a little and pay the minimum, maximize it and pay off in full, not using it at all. How you manage your variable debt tells lenders a lot about how you will manage future debts that you don’t already have.

If you don’t have both, start with a credit card first

If you don’t have credit accounts in your name and want to build your credit history, it’s best to start with a credit card designed for newbies.

CNBC Select ranked the best credit cards for credit building, and the Petal® 2 Visa® Cash Back, No Fees credit card topped the list of the best starter credit cards for a number of reasons.

First, the Petal 2 Visa credit card allows applicants with no credit history to apply and there are no fees *. If you have a credit file, it will be included in the credit decision. It also has a rewards program designed to help you establish good credit habits: 1% cashback on eligible purchases instantly, which can increase up to 1.5% cashback after 12 timely monthly payments. This is a great perk that can get you into the routine of paying monthly bills on time. Petal also offers 2 to 10% cashback from select retailers.

Another card to consider is the Capital One® Secured, which has a low security deposit (learn how secured credit cards work), and the Capital One® Platinum Credit Card, which is suitable for applicants with average creditworthiness.

At the end of the day, the most important thing is that you use your credit products to your advantage. Feel free to charge your credit card with expenses to earn points or refund; Just make sure that you can pay the remaining amount in full by the time the invoice is received. The same goes for installment loans such as personal loans, auto loans, and mortgages.

“Always pay your installment loans on time in the long run,” says Droske.

Do not miss: Revolving credit debt drops to $ 996 billion – its lowest level since the great recession

Information about the Capital One® Secured and Capital One® Platinum credit cards has been independently collected by CNBC and has not been verified or provided by the card issuer prior to publication.

Petal 2 Visa credit card issued by WebBank, FDIC member.

* The regular APR variable for the Petal® 2 “Cash Back, No Fees” Visa® credit card is currently between 12.99% and 26.99%

Note to editors: Opinions, analyzes, reviews or recommendations expressed in this article are solely those of the Select editorial team and have not been reviewed, approved or otherwise endorsed by third parties.

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