Types of Credit: The Different Types of Credit to Know About as a Consumer
Oftentimes, when a consumer wants to make a purchase, they’ll turn to credit accounts. For instance, a cell phone can be acquired thanks to a credit card, or a car with an auto loan. Of course, for the privilege of being able to do this, it’s expected that the lender is paid back by the consumer in good time, and often with added interest.
But did you know that the above—credit cards and auto loans, in addition to other credit accounts that haven’t yet been mentioned—are classified differently? And that there are three main types of credit?
If you’re new to the world of credit, you may not have known about the differentiation, or the reasons why they’re different in the first place. But by reading through this Grow Credit blog post, not only will you be able to understand what installment credit, revolving credit, and line of credit are, you’ll also learn what this means for your credit score, and how to ensure your credit score grows consistently.
Interested?
I thought so.
Just make your way through these sections to get thoroughly clued up:
Types of credit #1: Revolving credit
Types of credit #2: Installment credit
Types of credit #3: Line of credit
Do you need to have the three main types of credit for a good score?
Bettering your credit score as a consumer
Build, improve, and maintain your credit score with Grow Credit!
Let’s get on with the rest of the post.
Types of credit #1: Revolving credit
As mentioned a few moments ago, there are three types of credit, and revolving credit is perhaps the most common.
Revolving credit is what it sounds like: it’s where you can repeatedly borrow amounts from that line of credit to pay for whatever you deem necessary—but there’s usually a maximum limit that you can borrow up to, which is known as a credit limit. With revolving credit, it’s also usually possible to not incur any interest charge if you pay back the balance in full before the credit card statement date. If it’s not possible to do that, you’ll have to still pay the balance back, and this time with added interest.
If you’re currently thinking “that sounds a lot like a credit card!” you’re right—credit cards (but also some home equity lines of credit, known as “HELOCs,” too) are revolving credit.
Here’s a hypothetical example where a credit card is concerned.
Let’s say your washing machine broke down. There’s no hope of salvaging or fixing it, either: you need to fully replace the washing machine and buy a new one. After finding a store that offers next-day delivery, you pay a couple of hundred dollars for it (providing that your credit limit is big enough to make the purchase in the first place, that is). If your paycheck arrives in a few days, and well before your credit card statement date (which is when it will roll onto a new month afterward), you most likely (depending on your lender and your agreement with them!) won’t need to pay interest if the balance is paid in full.
However, if you do carry a balance (i.e. you couldn’t pay it off before the new month came), that’s when you’ll be charged interest. The added interest is basically for the privilege of being able to use revolving credit to make a purchase when you didn’t have enough to cover it yourself. It’s important to note that you usually make regular (i.e. monthly) but ultimately unfixed contributions toward your balance if it isn’t possible to pay it off in one fell swoop.
And that’s revolving credit in a nutshell.
Next up, installment credit.
Types of credit #2: Installment credit
Installment credit is a loan for a set amount—and usually given to you by the lender in one lump sum. Usually, you make fixed, regular repayments (quite possibly monthly) over a specific period of time to pay the sum back. Again, interest is very likely to be involved, and it’s not until everything is paid back that the account is considered closed.
You’ll have certainly heard about installment credit, even if you haven’t heard this exact term before. For example, when a student applies for and gets a student loan to pay for college, it’s given to them as installment credit, and then paid back—in this scenario, it’s usually paid back when the student graduates and earns an income. Home mortgages, auto loans, and personal loans are also installment credit.
An example won’t be given here as installment credit is pretty straightforward: if your application for installment credit is successful, you get a set amount, and then you pay it back with interest over a certain timeframe that the lender has agreed with you. It’s really as simple as that (as long as you’re able to keep up with repayments, of course—otherwise, it can get a bit more complicated).
To compare it with revolving credit, installment credit is typically involved when it comes to larger purchases like buying a house, while revolving credit can be for more every day, impromptu, or unforeseen purchases that need to be made.
That’s two out of the three main types of credit we’ve now looked at.
Last but by no means least is line of credit.
Types of credit #3: Line of credit
Line of credit can be either “open-end credit”—meaning there is no specific term or closure at a certain time—while “closed-end credit” allows advances as you need it, but at the end of a specific term, must be paid in full and closed. These are both credit lines in a preapproved amount that you borrow from, and up to a maximum amount. You then need to pay back the amount that’s been taken out before the end of a certain period—usually the end of each month.
But there’s a little more to know than just this.
On a line of credit, you make variable payments based on your usage of something. So, for instance, if you live somewhere that’s faced a particularly dark winter, you may have had the electricity on more than usual to stave away the lightlessness. You’re not paying for the electricity as you use it but instead, you use it, and then it’s paid back later on.
Speaking of electricity bills, it’s usually your utility bills—your cell phone bill, home internet bill, water bill, and so on—that work like lines of credit. (Charge cards are lines of credit, too.) Seeing as there’s so much variability with water, electricity, internet, and other utility usage, this method of borrowing and paying makes sense for both the lender and the lendee.
Now, if we were to compare lines of credit with revolving credit, there are some similarities but also some noteworthy differences—so let’s look at the main two. The ability to borrow up to a certain amount is perhaps the most major overlap. However, revolving credit doesn’t normally require you to pay back the balance in full within, let’s say, a month—but with a line of credit, that can be the case. Larger balance lines of credit (like home equity lines) can amortize the balance over a certain number of months, in order to make the payments more palatable.
Hopefully that’s cleared things up for you!
Do you need to have the three main types of credit for a good score?
Revolving credit. Installment credit. Line of credit.
You may not have all three credit types after graduating high school, college, or just generally when you’re in your 20s. But as you navigate further through adulthood, it’s likely that you’ll naturally end up with a credit mix of all three main types of credit. And this is by no means a bad thing—in fact, it could be good where your credit score is concerned.
You see, your credit score (which essentially tells lenders how trustworthy you are with using and paying back credit) is calculated with the following aspects in mind:
Payment history: 35%
Credit utilization: 30%
Length of credit history: 15%
Credit mix: 10%
New credit: 10%
As you can gather, paying and repaying credit and bills has the largest impact on your credit score, as does utilizing an appropriate amount of credit (it’s suggested that you use under 30% of total available credit for an improved credit score). However, having a mix of credit types does have an influence on your credit score.
Having a mixture of credit types—and not necessarily all three, either—proves that you’re capable of managing varying types of credit, and that you’re able to keep on top of any payments and repayments you need to make. Future lenders will know that it won’t be as much of a risk if they offer you another line of credit, as you’ve already proven you can successfully juggle a mix.
While it’s not certain for sure how many accounts you need to have the right kind of credit mix, managing more than one credit type will ensure you at least have a credit mix that will help influence your credit score!
What’s important to mention is that it isn’t the best of ideas focusing purely on credit mix when trying to better your credit score, though. There are more effective ways to do so, especially as a credit mix counts for just 10% in total.
Bettering your credit score as a consumer
Rather than focusing the majority of your time and effort on getting and sustaining a credit mix, prioritizing payments will serve you better when it comes to your credit score. Paying and repaying on time—or ahead of schedule!—and in full is what will most likely cause you to bump up your credit score from “poor” or “fair” to the ranks of “good” and beyond, purely because it’s weighted with more importance.
But it can be harder for some folks to pay and repay and have their credit score increase this way—perhaps they don’t have anything to pay back yet, or because they don’t have any bills to pay nor have their names on any utility bills, for example.
This is where credit-building tools, like Grow Credit, come in. Credit-building tools are useful for people who want to build their credit score from scratch, and for those who do have a credit score, but it isn’t quite where they want it to be, and are aiming for a higher, more favorable credit score.
Without further ado, here’s how Grow Credit works.
Build, improve, and maintain your credit score with Grow Credit!
Grow Credit enables U.S. residents to easily build, improve, and maintain their credit scores over time. Once you apply for our free and virtual Grow Credit Mastercard (which reports as a line of credit on your credit report), you’re then able to use the card to pay subscriptions for Netflix, Amazon Prime, Disney+, and more.
As long as you pay back the money that’s advanced from your Grow Credit Mastercard in good time, your credit score will increase over time! We report your payments to the major credit bureaus (Equifax, Experian, and TransUnion) so they’re able to amend your credit score accordingly.
Whether you want a better credit score so you’re offered more impressive credit cards, or to help you clinch a home mortgage, Grow Credit can help you get where you want to go.
If you’re more of a visual learner, check out the video below.
Applying for a Grow Credit Mastercard takes hardly any time at all. Just download our iOS or Android app to join the Grow Credit program, or do so via our website. All that’s needed for you to get started is to have the following (and in your own name):
A bank account (that’s been open for at least 60 days)
A valid email address
A working phone number
A Social Security number
A physical U.S. address and resident status
A minimum income of $1,200 per month (for at least two months)
An account balance of at least $100
And to be age 18+
Do you meet this short list of requirements?
If so, then it’s time to grow your credit score with Grow Credit.