Revolving Debt vs. Installment Loans: Why the Type of Account Matters to Your Credit Score

When it comes to how your credit scores are calculated, there are many factors at play. Credit scoring models consider how well (or how poorly) you pay your bills. They also consider what kind of debt you have, and how much of it you’ve got.

The list goes on and on, but if you want to earn and maintain great credit scores, you’ll need to perform well across all of the various credit scoring metrics. That means understanding which factors matter, and matter the most, to your credit scores.

One such factor that often leaves consumers scratching their heads is the fact that credit scoring models like FICO and VantageScore will focus on the various types of accounts on your credit reports rather than just how well you pay them.

More specifically, the different types of debt you choose to carry will influence your scores differently. One type of debt may have very little impact on your credit score, while others can send your score spiraling in the wrong direction — even if you make every single payment in a timely fashion.

The Different Types of Debt

There are many kinds of accounts that can appear on your credit reports. These accounts may range from credit cards to student loans to mortgages, just to name a few. However, the majority of the of accounts on your credit reports can be classified into one of two categories: revolving accounts or installment accounts.

Installment Accounts

When you take out an installment loan, the terms of your loan will typically require a fixed monthly payment over a predetermined period of time. For example, your auto loan might require you to make monthly payments of $300 over a period of five years.

Some common types of installment accounts may include student loans, personal loans, credit builder loans, auto loans, and mortgages. And, most of the time these types of loans will be secured by some asset, such as a car or a home. The notable exception, of course, is a student loan.

Revolving Accounts

The most common type of revolving accounts are credit cards. Unlike installment loans where you borrow one time (upfront) and will likely make a fixed monthly payment throughout the life of the loan, revolving credit card accounts work quite differently. With a credit card account, you generally have a set credit limit and you can borrow up to that maximum limit on a monthly basis.

The borrower can either pay the account balance in full each month, pay it off partially, or make a minimum payment as required by the lender. And, you can continue to draw down against your credit limit as long as you make payments on time. This type of debt is almost never secured by an asset, unless it’s a revolving home equity line of credit.

How Credit Scoring Models View Your Debts Differently

Your payment history: FICO and VantageScore, the two most popular credit scoring models, both treat the installment debt and the revolving debt on your credit reports very differently. However, when it comes to any account on your credit reports, the most important factor considered in the calculation of your credit scores is whether or not you pay as agreed.

If your payment history shows late payments on any account, whether it be a revolving account or an installment account, the impact on your credit scores is likely going to be negative. A late payment on an installment account and a late payment on a revolving account would likely be similarly damaging to your credit scores. Late is late.

Amounts owed: The balances on your accounts (i.e., the amount of debt owed) are another matter when it comes to credit scoring. In this credit scoring category, installment debt and revolving debt are not treated equally.

Credit scoring models will pay a lot of attention to your revolving utilization ratios — that is to say, the relationship between your credit card limits and credit card balances. When you carry a high percentage of credit card debt compared to your credit card limits, your credit scores are going to almost certainly begin to trend downward.

Conversely, you can carry a large amount of installment debt, such as a mortgage loan, and the impact of the balance of the installment loan on your credit scores is likely to be very minimal. For that reason it’s completely possible for a small $5,000 credit card balance (especially on an account with a low credit limit) to have a much more damaging impact on your credit scores than a $500,000 mortgage balance. I know, that’s hard to believe.

The Reason for Different Treatment

Many consumers wonder why credit card debt, even if it is paid on time, can have such a potentially negative impact on their credit scores when installment accounts are not treated in the same manner.

The answer is simple: Revolving debt is much more predictive or indicative of elevated credit risk. As such, it’s going to be much more harmful to you credit scores.

Installment debt, which is almost always secured, is a much less risky type of debt, primarily because people know if they stop making their payments they can lose their car or their home.

Related Articles

John Ulzheimer is an expert on credit reporting, credit scoring, and identity theft. He has written four books on the topic and has been interviewed and quoted thousands of times over the past 10 years. With time spent at Equifax and FICO, Ulzheimer is the only credit expert who actually comes from the credit industry. He has been an expert witness in over 230 credit related lawsuits and has been qualified to testify in both federal and state courts on the topic of consumer credit.

The post Revolving Debt vs. Installment Loans: Why the Type of Account Matters to Your Credit Score appeared first on The Simple Dollar.

Comparing Your Many Credit Scores

Credit scores make the financial world go round, or so the saying goes. And while that may be a slight exaggeration, the truth is that your credit scores are going to have a significant impact on your money.

Lenders rely on your credit scores to decide whether or not they want to do business with you and under what terms. Insurance companies rely on scores to help them determine how much to charge you for your insurance premiums. Even utility and mobile phone providers will use your credit scores to determine whether you’re eligible for service and, if so, how much you will have to put down as a deposit (if one is required) to open a new account.

When it comes to the subject of credit scores, there is a lot of confusion among consumers about just how many credit scores actually exist. Many consumers mistakenly believe they have only one credit score. Others will swear they have three credit scores. However, both of the previous assumptions are completely wrong. The truth will probably surprise you: You actually have hundreds of different credit scores.

What Is a Credit Score?

Hearing that there are hundreds of credit scores may feel a bit overwhelming, but once you understand more about credit scores, the easier it is to digest the revelation.

Credit scores are used to evaluate the information contained in your credit report and translate it to an easy-to-use number. The number, your credit score, is then used by lenders and other companies who may wish to extend credit to you (i.e. lenders, landlords, insurance providers, etc.) to help them make more informed business decisions.

Credit scores help lenders predict whether or not you’re likely to pay back your debt according to the terms of your agreement. FICO and VantageScore credit scores, the most common brands of scores, have a stated design objective of determining how likely you are to become 90 days late on any credit obligation within the next two years. The more likely you are to actually become 90 days late on an account, the lower your FICO and VantageScore credit scores will be.

Different Credit Score Brands

The majority of lenders currently rely on the FICO brand of credit scores, but that’s changing with the introduction of the VantageScore brand. And although many people use the term “FICO score” as if it were synonymous with “credit score,” that’s not the case.

Think of the term credit score as a category of products… like cereal or soft drinks. Within the category of products there are brands… like Cheerios and Coke. And even further down, within the brand, there are variations of the brand — like Honey Nut Cheerios and Diet Coke.

So, whenever you hear people use the term “credit score” or “FICO score,” they’re really referring to a brand or type of product, and not a specific credit scoring model.

Different Varieties and Generations of Credit Scores

Just like Ford does not make only one type of vehicle, neither does FICO or VantageScore make a single credit score. And, just because Ford makes a 2016 Mustang, that doesn’t mean that all Mustangs are from 2016.

Now apply this understanding to credit scores and you’ll be well on your way to understanding why you’ve got so many.

Because FICO has been around for so long (the first FICO credit bureau score was introduced in 1989), there are going to be more generations of their scoring models than any other brand. Every few years FICO releases a new generation of their credit scores, but that doesn’t mean the older versions are shut off. To the contrary, the older versions are still maintained and commercially available, and used by lenders.

What ends up happening is that these multiple generations of scores pile up, and that’s the primary reason why you don’t have just one credit score. In fact, under the FICO brand you have dozens of scores.

Under the VantageScore brand you’ve got nine different scores, which is made up of three generations of their scoring model times the three big credit bureaus. And while their scoring model is the same across all three credit bureaus, your scores are not likely to be the same — because your credit reports will likely be different. Different data in means different credit scores coming out.

What Can I Do About All These Credit Scores?

First and foremost, you can stop worrying about it. You’ve got more credit scores than you’ll ever see, and there’s nothing you can do about it. And even if you did have access to all of your credit scores, there’s no reason to believe you’d be able to max out each of them, because they all consider things differently.

For example, newer credit scoring systems ignore collections that have a zero balance. But, the older generations of credit score models do not ignore zero-dollar collections.

What you can do, however, is make sure the information on your credit reports is 100% accurate.

All credit scores consider the information on your credit reports — nothing more and nothing less. And because you have only three credit reports, making sure they’re all accurate and impressive is a whole lot easier than chasing around dozens of different credit scores.

If you’re able to keep really great credit reports, then each and every one of your credit scores is also going to be great, regardless of the brand or generation of the specific score.

Related Articles:

John Ulzheimer is an expert on credit reporting, credit scoring, and identity theft. He has written four books on the topic and has been interviewed and quoted thousands of times over the past 10 years. With time spent at Equifax and FICO, Ulzheimer is the only credit expert who actually comes from the credit industry. He has been an expert witness in over 230 credit related lawsuits and has been qualified to testify in both federal and state courts on the topic of consumer credit.

The post Comparing Your Many Credit Scores appeared first on The Simple Dollar.