The Two Flavors of Credit: Revolving vs. Installment

Let's start with revolving credit. Picture an open feeder tray filled with seeds. You can dip in and grab a few seeds (borrow money), and as you gather more, the tray empties a little. As you replenish the seeds (make payments), the tray fills up again.

Credit cards are the most common form of revolving credit. You have a credit limit, and you can borrow up to that limit, repay it, and borrow again. This flexibility is a major advantage. You can use your credit card for everyday purchases, emergencies, or even to earn rewards like cashback or travel points.

However, this flexibility also comes with responsibility. If you don't manage your spending and repayments carefully, you can quickly rack up debt and high-interest charges. For example, let's say you have a credit card with a $1,000 limit. You spend $300 on groceries, $200 on gas, and $100 on a new gadget. Your available credit is now $400. When you make a payment of $200, your available credit goes back up to $600. You can then borrow up to that amount again.

The key is to keep your credit utilization-the amount you owe compared to your credit limit-low. Aim for under 30% to show lenders you're responsible. You can learn more about why that’s important by reading The 30% Rule: Why Credit Utilization is Your Dinner Plate.

Now, let's talk about installment credit. Imagine a steady ration, carefully measured out and delivered on a schedule. This is what installment credit is like. You borrow a fixed amount of money and repay it over a set period with scheduled payments.

Loans, such as auto loans, mortgages, and student loans, are examples of installment credit. With installment credit, you know exactly how much you owe each month and when the loan will be paid off. This predictability can make it easier to budget and manage your finances.

For example, let's say you take out a $10,000 auto loan with a 5-year repayment term. Your monthly payment will be a fixed amount, say $200, and you'll make that payment every month for 60 months. At the end of the 5 years, the loan will be paid off.

Installment loans offer stability and structure. They can be very helpful to manage larger purchases (car, home) or investment in your education, but you need to be very careful about your ability to make those payments on time every month. Missing payments can damage your credit and potentially cause you to lose the asset backing the loan. You can explore an example of installment credit in "Credit-Builder Loans."

One important aspect of revolving credit is the concept of Authorized User (AU) accounts. An AU is someone who is added to an existing credit card account but is not legally responsible for the debt.

Being an AU can be a fast way to build credit, especially if the primary cardholder has a long history of responsible credit use. Think of it like adding a strong branch to your nest-it provides immediate stability and visibility. The catch is that you're relying on someone else's good habits. If the primary cardholder misses payments or maxes out the card, it can negatively impact your credit score.

You can gain a deeper understanding of the role of authorized users on your credit profile in our guide, "Understanding Tradelines."

When you look at your credit report, you'll see tradelines, which are records of your credit accounts. These tradelines show lenders the type of account (revolving or installment), the credit limit or loan amount, the payment history, and other relevant information. These tradelines are the foundation of the "nest" you present to lenders.

It’s also important to understand how payment history can affect your credit profile and the importance of making on-time payments. As we mentioned in Understanding the 35% Rule: Why Payment History is the Bedrock, payment history is the most important factor in determining your credit score.

It's essential to understand that adding an AU account, or 'piggybacking' onto someone's credit, is not a guaranteed solution. While it can provide a quick boost, it's crucial to remember that lenders and credit scoring models may treat AU accounts differently.

Important Disclosure: Some lenders and credit scoring models may filter out, discount, or weigh authorized user tradelines differently in their underwriting decisions. Results vary based on lender policies, the specific scoring model used, and your unique credit profile. An AU tradeline does not guarantee loan approval or any specific credit score outcome.

Some lenders may discount or disregard AU accounts, especially if they suspect that the relationship is not genuine. Always be upfront and transparent with lenders about your credit history and any AU accounts you have. The bureaus are, after all, "Meet the Nest Keepers: The 3 Credit Bureaus," and can each record tradelines differently.

Similarly, a thin file can be a challenge as lenders want to see a well-established history. To understand how your credit history is viewed by lenders, check out "The Anatomy of a Credit Report: What Lenders See." It’s important to be honest about your financial habits and credit history. A balanced and diverse approach to building credit is essential. Relying solely on AU accounts is not a sustainable strategy.

Let's look at a few examples to illustrate the difference between revolving and installment credit and how AU accounts can play a role.

• Newcomer Nico: Nico is new to the US and has a thin credit file. They want to get approved for an apartment and a mobile phone. They are added as an AU to a family member's credit card with a long history of on-time payments and low utilization. This quickly boosts Nico's credit score, allowing them to get approved for the apartment and phone.

• Rebuilder Riley: Riley had some financial difficulties in the past and has a few late payments and collections on their credit report. They want to stabilize their credit score and save on borrowing costs. Riley takes out a credit-builder loan, an installment loan designed to help people with poor credit build a positive payment history. Over time, the consistent on-time payments help Riley improve their credit score and qualify for better interest rates.

• Time-Sensitive Taylor: Taylor is planning to buy a home in six months and needs to improve their credit score quickly to get approved for a mortgage. They open a secured credit card (revolving) and diligently keep the utilization low and payments on time. At the same time, a family member adds them as an AU to their credit card. The combination of responsible revolving credit use and the AU account helps Taylor boost their credit score in time to qualify for the mortgage.

So, what are the key takeaways? Here's a quick action plan:

• Understand the difference: Revolving vs. installment credit-know the pros and cons of each.

• Manage your revolving credit: Keep credit utilization low (under 30%) and pay your bills on time.

• Consider installment credit: Explore loans (secured, credit-builder) for long-term credit building.

• Evaluate AU accounts: Understand the risks and benefits before becoming an Authorized User.

• Monitor your credit report: Regularly check your credit report for errors and track your credit progress. By understanding the nuances of revolving and installment credit, you can build a strong and sustainable credit profile.

As you embark on your credit-building journey, remember that the fastest credible gateway is often an Authorized User tradeline, which provides quick visibility and can boost your score rapidly. However, for long-term strength and resilience, it's essential to build your own accounts and habits. Consider opening a secured credit card or taking out a credit-builder loan to establish your own credit history. Think of it as adding your own sturdy branches to your nest, making it stronger and more secure. You can explore authorized-user tradelines to get a quick start, and also build long-term strength with secured cards, credit-builder loans, and rent reporting.

Just as a bird meticulously gathers twigs and weaves them into a secure nest, you too can build a strong financial roost by understanding and managing the different types of credit available to you. With a clear understanding of revolving and installment credit, you can confidently navigate the world of credit and build a solid foundation for your financial future.

1. Which is better for building credit: a credit card or a loan?

• Both are important. Revolving credit (cards) is better for long-term history, while installment loans add to your credit mix.

2. Do I need an installment loan to have a good credit score?

• Not strictly necessary, but having a "credit mix" of both revolving and installment accounts can boost your score.

3. Does paying off an installment loan early help my score?

• Sometimes it can actually cause a small drop because the account is closed, reducing your credit mix and open accounts.

4. Are student loans considered installment credit?

• Yes. Student loans, auto loans, and mortgages are all types of installment credit with fixed repayment schedules.

5. What is a "credit mix" and why does it matter?

• It's having both revolving (cards) and installment (loans) accounts. It shows lenders you can handle different types of debt responsibilities.

6. Can I build credit with just installment loans?

• Yes, but it's slower. Revolving credit is generally more effective for long-term score building because it doesn't "end" like a loan does.