Most people understand that credit cards and loans are two different things. While both offer borrowers or cardholders a way to access funds to make purchases, they do so in different ways. What many borrowers may not realize is that both are considered a type of credit account.
In fact, there are three different types of credit accounts; revolving, installment, and open accounts. All types of credit accounts have an effect on your credit score. On-time payments can help boost your score, while late payments or a debt-heavy debt-to-credit ratio can cause it to drop. But understanding what different types of credit accounts really are and how they differ is a must if you want to improve your score.
Keep reading to learn about all three types of credit accounts, the role they play in your finances, and which are the best to have.
What are Revolving Credit Accounts?
One type of credit account is a revolving credit account. What is a revolving credit account? This credit option is one that allows account holders to borrow freely, but with a cap on how much they can borrow. The most common type of revolving credit account is a credit card.
When you apply for a credit card, you receive a set line of credit. In most cases, this line of credit will stay the same, unless you request an increase or the bank decides to reduce your line of credit. You can borrow up to that amount by using your card. If you pay down your balance, you can then borrow up to that amount again. This can be done again and again and again — just as long as you follow the terms of your card. This means making monthly payments on your credit card when you have a balance.
Typically, revolving credit accounts like credit cards also carry interest. So when you use your card, you’ll also pay interest on the balance that you carry over into the next month.
Other Types of Revolving Credit Accounts
Credit cards aren’t the only type of revolving credit accounts. Home equity lines of credit, or HELOCs, and personal lines of credit are also revolving accounts.
HELOCs allow you to borrow money against your home’s equity. Your home’s equity is the monetary difference between what you still owe on your home and what your home is now worth. Even if you’ve only been paying your mortgage for a few years, if the value of your home and property has increased during that time period, you may have a significant source from which to borrow in the form of a HELOC.
While a HELOC is a great way to get access to funds when you need them for a big purchase, like renovations to your home, they do have a drawback — if you default on this loan, your home could go into foreclosure just as it would if you failed to pay your mortgage.
A personal line of credit is similar to a credit card in that you can borrow from it freely. However, a personal line of credit typically comes with a draw period. After that period is over, you can no longer borrow money. That’s also when the countdown starts; you’ll have a set period of time to pay back any remaining balance you’re still carrying.
What are Instalment Credit Accounts?
Another common type of credit account is an installment credit account. What is an installment credit account? Any loan for a set amount of money that requires fixed repayments on a schedule falls under this category. This includes a wide variety of common loans, including:
- Auto loans
- Student loans
- Personal loans
Unlike a credit card, once you apply for and receive an installment credit account in the form of a loan, you can’t borrow additional funds. Even if you make payments towards your loan to pay back your balance, you won’t be able to borrow from those funds that you’ve paid back.
Like credit cards, loans carry interest rates. These, much like the loan amount that you borrow and the timeline for repayment, will vary from one loan to the next. Also like credit cards, these types of loans affect your credit score. They are factored into your total debt amount, which accounts for a percentage of your credit score. But making timely payments towards your loans can help to boost your credit score.
What are Open Credit Accounts?
While revolving credit accounts and installment credit accounts are common, this next type of account is much less so. With open credit accounts, borrowers can take advantage of a set amount of funds available. However, they must repay what they borrow in full before the pre-set deadline. While there is no interest involved, there are penalties for failing to pay back the full amount borrowed on time.
Open credit accounts are rare. They are most often associated with charge cards, which aren’t often available to borrowers today.
What are the Best Credit Accounts to Have?
While open credit accounts are rare today, the other two types of credit accounts are very common. Most adults today have a credit card — in fact, the average in the U.S. is four credit cards in every adult’s wallet. And installment credit accounts are a must for most people looking to buy a car, a home, or go to college.
So what are the best credit accounts to have? This largely depends on how you plan to use them, and your ability to make payments on time and in full. Having a credit card can be a great way to boost your credit score, but only if you never miss a payment and keep your debt utilization ratio below 30 percent. Using a loan to purchase a car can also help improve your score. But missing payments will hurt your score, among other consequences.
The major credit bureaus do not provide information about how much having different types of credit accounts actually affects your score. However, it is known that having a mix of accounts and making payments promptly does have a positive effect on your score.
Repairing Damage from Past or Current Credit Accounts
If you’ve struggled in the past to make payments to your various types of credit accounts or are currently struggling, it’s important to take measures to fix your past mistakes and repair the damage to your credit.
Credit Ninja can help you begin the journey of repairing your credit. By tracking down and fixing mistakes on your report, we help boost your score and empower you to begin taking measures to improve your future finances. Learn more about Credit Ninja and our CIG Platinum Membership today!