The Difference Between Revolving Debt and Installment Debt

If you’re familiar with credit score basics, you already know that payment history is a major factor in your score. But did you know that the type of debt you have is important, too?

Not all debts are equal in the eyes of credit scoring agencies. In this post, we’ll cover the two major categories—revolving debt vs. installment debt—and explain how they influence your credit score.

revolving-debt-vs-installment-debt

Revolving Debt vs. Installment Debt

What is revolving debt?  

Credit cards are the most well-known type of revolving debt. With revolving debt, you borrow against an established credit limit. As long as you haven’t hit your limit, you can keep borrowing.

Credit cards require a monthly payment. If you pay the balance in full each month, no interest will be charged. Whenever you pay less than the full balance, you’ll be charged interest.

Interest rates on credit cards can be high. The national average annual percentage rate (APR) is currently over 16%.1 Plus, interest on credit cards compounds, so the longer you wait to pay off the balance, the more you’ll owe in interest. An online calculator  can help you see how credit card interest adds up over time.

Credit cards are unsecured, meaning they are not backed by an asset. A home equity line of credit is also revolving debt, but it is secured by your home—which means the lender can foreclose on your house if you stop making payments. 

What is installment debt?

With installment debt, you borrow a fixed amount in one lump sum; unlike a credit card, you can’t keep borrowing as you pay off your balance. Installment loans have predetermined end dates, so you know when you’ll be done with the loan. Mortgages, auto loans, student loans and personal loans are all examples of installment debt.

Installment debt can be secured (like auto loans or mortgages) or unsecured (like personal loans). Interest rates on secured loans are typically lower than on unsecured loans.

Revolving debt vs installment debt: What do they mean for your credit score?

Here are a few common questions about how revolving and installment debt impact your credit score.

Which type of debt makes a bigger impact on your credit score?
Both revolving debt and installment debt impact your credit score—but revolving debt in the form of credit cards is especially significant. That’s because scoring agencies believe that credit card debt is a more reliable indicator of your risk as a borrower than installment debt.

How does revolving debt impact your score?
The outsized impact on your credit score is mostly due to credit utilization. Credit utilization measures the balances you owe on your credit cards relative to the cards’ credit limits. Both VantageScore and FICO, two big credit scoring agencies, list credit utilization as the second highest factor they consider when determining credit score. If your utilization ratio is high, it indicates that you may be overspending—and that can negatively impact your score.

What’s a good credit utilization ratio?
The general rule of thumb is to stay below 30%. This applies to each individual card and your total credit utilization ratio across all cards. Anything higher than 30% can decrease your credit score and make lenders worry that you’re overextended and will have difficulty repaying new debt.

What other characteristics of revolving debt impact your credit score?
In addition to the dollar value of revolving balances—part of your credit utilization ratio—credit scoring models also look at the number of open revolving accounts you have and their age. Older accounts are generally more beneficial for your credit score, since they demonstrate you have a stable history of responsibly managing credit.

How many revolving credit card accounts is too many?
When it comes to the number of open credit card accounts, there is no magic quantity that will be most beneficial to your credit score. On average, Americans have 3.4 credit cards and a VantageScore of about 673, which falls into the “fair” category.2 If you are managing your credit card debt responsibly, having more accounts could actually benefit your score: the “Guinness Book of World Records” features a borrower with nearly 1,500 credit cards and an almost perfect credit score.3 On the other hand, if you only have one card but are falling behind on payments, your credit score will decline. Many people find that having lots of accounts means they spend lots of time monitoring their statements, which can be time consuming.

How does installment debt impact your score?
Credit scoring agencies consider installment debt to be less risky than revolving credit card debt, partly because installment debt is often secured by an asset that the borrower won’t want to lose. Additionally, installment loans—even big ones like mortgages—are considered relatively stable, and therefore have less influence on your credit score than credit card debt. Many borrowers are easily able to achieve VantageScores above 700 while managing larger balances of installment debt.

What’s the ideal ratio of installment and revolving debt?
Your credit mix—the different types of loan products in your credit history—also influences your credit score, albeit on a smaller scale. Scoring models often take into account your ability to responsibly manage both revolving and installment debt. While there is no formula for the perfect mix, blending multiple types of debt is generally beneficial to your credit score.

Which is better to pay off first?
If you are aiming to improve your credit score by paying off debt, start with revolving credit card debt. Because credit cards have a heavier impact on your score than installment loans, you’ll see more improvement in your score if you prioritize their payoff. Plus, they often come with larger interest rates than installment debt, so it can save you money to tackle your credit cards first.

How can installment debt help pay off revolving debt?
Some borrowers choose to pay down their credit card debt by taking out a new, personal installment loan with more attractive terms than their credit cards. If you choose to consolidate your credit card debt with a personal loan, you can look forward to a fixed payoff date and making payments on just one account each month.

Once you pay off a card—either via consolidation with a personal loan, or by making regular monthly payments—you may want to leave the card open. By paying off the card, you’re reducing your total balance, and by keeping the card open, you’re maintaining the total limit—thereby lowering your credit utilization ratio. One possible exception: if your card has an annual fee you may want to close it once its paid off.

The Bottom line

While your mix of revolving and installment debt matters, on-time payments are crucial to protecting your credit score—no matter which type of debt you have. Any type of debt that you aren’t paying back on time will do serious damage to your score.

 

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1. CreditCards.com Interest Rate Survey
2. Gallup Debt Analysis; Experian Average Vantage Score; Transunion Credit Score Categories
3. Guinness Book of World Records