The art of protecting your credit score is perhaps learned over the time. While it is a common knowledge that the credit repayment and credit utilization ratio are the two most important factors touching your credit report, it is rarely understood practically.
Mostly underrated is another calculation factor for credit scores is the type of credit drawn. It indeed affects the score the most and can have a far worse bearing on your credit score.
Very few of us realize that late payment of 2000000 home loan for 10 years would not hurt your credit score as much as the balance of 20000 on your credit card would do. Let’s understand why so?
In simple words the difference is basically due to the difference in the nature of loan. When you draw a loan such as a home loan, a car loan or any other purpose loan you raise credit on installments. These all are examples of installment loans.
While your credit card limit is in the form of revolving credit where in you have freedom to choose your loan and its repayment.
To understand the difference between the two let’s elaborate further on the difference between revolving credit and installment loans.
Basically there are two types of accounts that appear on your credit information report– Revolving credit and installment credit. Any type of loan or credit product would be using any of these repayment methods, none can use both.
Loans with fixed interest rate and duration such as personal loans, auto loans and home loans are type of Installment credit. They are repaid with pre-scheduled payments. They are drawn for a fixed amount at a fixed (or variable) interest rate and for a set period of time. As you repay the Installment loan over the credit duration, principal amount reduces and the loan closes with the full repayment. However the payment on revolving credit is not fixed, it is open-ended. You can repay and borrow as per your requirement up to the credit limit. One of the most commonly used revolving debt line is credit card.
Both forms of debt can be raised as secured and unsecured forms, but commonly installment loans are secured loans.
In the installment loans the duration of the loan is fixed however in revolving credit you never borrow a lump sum amount and thus there is no fixed payment plan or a fixed duration. You can pay in full, partly or roll back the balance according to your convenience.
The rate of interest on installment loans can be variable or fixed. Even in case of variable interest rate the amount paid as interest on installment rate falls under a market range and thus installment loans are never too costly. They are charged as per the market standards and are affordable. There are no surprise factors involved.
However the flexibility of revolving line of credit to repay often takes a toll on credit score. This flexibility calls for higher rate of interest. In case of failure in repayment, rate of interest can rise even further. The creditor have all rights to increase the rate any time.
So, revolving credit can be said to be precarious for credit score as compared to installment loans. I hope this make you understand why carrying forward the balance on your credit card from one month to the other month drags down your score.
While the regular payment of loans and bills boosts your score by 35 per cent, the exhaustion of credit limit hurts your score by 30 per cent.
When your score tumbles down clearing off credit card balance is one of the fastest ways to improve the score. More so, many a times a professional credit counselor would advise you to draw installment loans to close the revolving credit in order to build your score. Generally personal loans are used to close high-rate revolving credit lines.
It is important to know here that by repaying your credit card balance regularly you can also build good history. It also make you eligible for increasing your limit. As the over usage hurts your score, keeping the credit usage below 30 % also helps your score grow. So you can use credit card limits to increase your credit worth.