Understanding the Different Types of Credit
Credit seems straightforward enough - borrow money and pay it back over time plus interest. But it's important to understand there are different types of credit and situations in which one may be a better financial choice.
The two main types of credit are installment and revolving credit. Mortgages are an example of installment credit while credit cards are an example of revolving credit.
How Installment Credit Works
People use installment loans to pay for expensive things like homes, cars and college costs. The loan is for a set amount of money and you receive the money in a lump sum. You have a pre-determined amount of time to repay the loan, usually several years. Your loan can have a fixed interest rate (does not change during the repayment period) or a variable rate (the rate can rise).
There are two types of installment loans:
Benefits of an installment loan:
How Revolving Credit Works
Revolving credit is an open-ended form of borrowing. You get a credit limit (the maximum you can borrow) and then use the credit and pay it back over time. As you use it, the amount of money available to you decreases. As you repay it, it goes back up.
Credit cards have some advantages:
Credit cards usually charge annual fees and fees for going over your credit limit or making balance transfers. Since there is no set amount of time for paying your balance off, your debt can increase substantially over time. In addition, if you don't pay your full balance each month, you pay interest on both the amount of money you spent using the card plus the interest you've built up. The amount you owe can grow quickly.
Choose the Right Type of Credit
By knowing the pros and cons of installment and revolving credit, you can choose the right type of credit for your purchase and financial situation and work to build your good credit.
This article is for informational purposes only. For personalized financial advice, you should contact a qualified financial advisor.