Understanding Different Types of Credit While credit at its most basic seems simple — borrow money from someone and make payments with interest until it’s paid back — there are different types of credit. Each kind of credit has different effects on your credit score and has its own benefits and pitfalls.
Installment credit, or installment loans, are used to buy large ticket items — houses, cars and college tuition, among others. This kind of loan sees you receiving a fixed amount of money from a creditor which is usually a bank, credit union or financing company. You then have a set amount of time in which to pay back the loan. Car loans, for example, are usually for five or six years.
Installment loans can have either fixed or variable interest rates. A variable rate can rise and fall based on current federal interest rates, while a fixed rate stays the same for the life of the loan regardless of economic conditions. The two types of installment loans can be either secured, which uses collateral to insure the loan, or unsecured, which usually carries a higher interest rate and a higher risk of credit rating damage.
There are several benefits to this type of loan. First, if you can get a fixed rate, you will have an easy time budgeting payments as they will remain the same every month for the life of the loan. Installment loans also usually carry lower interest rates than other types of credits. Your balance is guaranteed to decrease over time so you will see your debt diminish. Finally, you only pay interest on the original cash borrowed.
Credit cards, lines of credit and the like are called revolving credit. This open-ended borrowing gives you a limit and you can use the credit as needed, paying it back over time. There is generally no collateral involved in revolving credit, and after you get the card or line of credit you don’t have to apply to use it every time. However, this type of credit carries higher interest rates and is almost entirely based upon your credit score.
The big risk with this kind of credit is that your interest rate alone can outstrip your minimum payment, meaning you are struggling to keep your debt even and may have difficulty reducing your debt. In addition, late payments can have a severe effect on your credit score.
Revolving Credit Benefits
When you receive a credit card or line of credit, you can use it as you like, whenever you need. There are no additional applications required. This makes it a supremely flexible means of covering emergency expenses. In addition, if you can afford to do so, you can alter your monthly payments to pay down the debt faster.
The different types of credit each have their own benefits and drawbacks. Understanding these will help you make the right choice when you need to make a purchase. If you need credit to buy a new car, we can help. Read about our buy here pay here financing and contact us today to get started!