Whether you are a single person just starting life on your own, a couple looking to buy your first home, or a budding entrepreneur seeking to start a business, credit affects every aspect of your life. Credit affects your financial health and ability to get what you want, find a place to live, and much more.
Not learning about different kinds of credit and how to manage it can severely affect your life, leading to a poor credit history. Lenders will not trust you, making it difficult to live a comfortable life and, in some cases, even prevent getting the job you want.
Credit isn't a one-size-fits-all proposition. We'll go over the different credit types, how each works, and what you can do to get and maintain good credit.
Generally, consumers will find three major types of credit: revolving, installment, and open. The type you apply for and hopefully receive approval for depends on your needs.
Credit is a contractual agreement in which you, the borrower, receive something of value, such as a car, a large appliance or even money. You agree to repay the money over time, usually with interest.
According to Credit Karma, understanding the different credit types and how to use them shows financial institutions, credit card companies and others that you can handle money responsibly.
Successfully managing different credit and the payment systems that go with them can help strengthen your credit score.
Here is an overview of the three main types of credit:
Revolving accounts have a set amount of funds available to consumers even as they pay their balances. The amount remaining available decreases as you use it but increases when you pay all or part of the balance.
If you have several revolving accounts in good standing, your status demonstrates that you are a good credit risk. Many lenders consider good revolving credit as pre-approval for other types of loans. Examples include:
Using revolving accounts can become a risky way to borrow if you don't use your available funds wisely. Keep your credit utilization rate low, below 30%, if possible. Other tips include:
Installment credit involves borrowing a fixed sum of money with a set number of payments you agree to pay over time.
These loans can come with fixed or variable rates, meaning payments can increase or decrease with the latter type, especially if your agreement is tied to the prime interest rate. Examples of installment lines of credit are:
Lenders typically tailor installment loans to meet the specific needs of borrowers. This feature often makes them a good choice for consumers and businesses. They are attractive because of their many advantages, including:
Nevertheless, you may encounter disadvantages, such as:
Taking out installment lines with long terms can be risky if your personal circumstances change during the course of the loan.
If you cannot avoid a long term, try making more than the minimum payment as much as possible to pay down the principal.
When you have an open line, it essentially means you don't have a hard-set credit limit. Payments are usually due in full each month and can vary, as these usually depend on the usage of something involved in a contract or a service. Examples are:
Open credit is readily available for many consumers, often not requiring consumers to reapply for funds when emergencies arise. Lower interest rates also make this alternative attractive.
Disadvantages include higher interest rates and unexpected maintenance fees. The lender may also suddenly decide to change terms, which many consumers may miss or not understand, ultimately resulting in higher costs.
When it comes to open lines of funding, manage them as you would a revolving card account. Don't overextend your usage; pay as much as you can toward your monthly balance.
This term is confusing, as some financial entities use it to designate accounts that are no longer open, i.e., closed.
However, closed credit refers explicitly to instances where consumers apply for a specific amount of money, which they receive and repay in fixed payment. Closed credit examples:
With a closed credit account, you can't spend more than the amount initially lent. The most significant disadvantage is that you don't have the flexibility available with open accounts.
Closed credit also encompasses no longer active accounts, meaning you can't access funds. Manage these accounts by trying to remove them from the three major credit reporting bureaus.
Secured credit is a type of credit account where collateral guarantees the amount given to borrowers by a lender.
These financial instruments are usually lump sum installment loans where the item you purchase with the credit serves as collateral. Secured credit examples are:
Secured credit can allow those with little or no credit history to build their credit reputation for lenders. Getting approval for a secured line can help you obtain funds that you otherwise be able to get with an unsecured line.
The primary disadvantage of secured credit is that you can lose your collateral if you default on the loan. The lender can repossess your vehicle or home if you fall behind on payments.
These tips pertain mainly to charge cards. Self Inc. recommends you do the following:
This credit type refers to credit lines or loans not guaranteed by collateral.
These generally encompass many loans or revolving cards, but some financial experts say the latter should be in a separate category as all differ in offerings and structure. Examples of unsecured credit include:
Are you seeking lower interest rates? If so, you'll love unsecured loans and credit lines. Other advantages you'll find are:
Disadvantages are significant:
Managing unsecured funds typically follows that for credit cards. Rules to follow include:
The number reported by the three agencies is your score, which is a significant component of creditworthiness and factors into your report from each agency.
These two elements combined can determine whether lenders will take a risk and provide you with a loan or deny you because they believe you won't repay your debt.
Lenders, whether they are credit card companies, financial institutions or other entities, must have some basis to determine your creditworthiness.
Bad scores and reports can drag you down, while good scores can lift you up.
The biggest factor affecting your score is how you pay your credit bills. Other important factors include your usage ratio and credit mix.
Checking both is quite simple as many banks and credit crds give you this information for free. Just go to freecreditreport.com to get a report from all three major U.S. credit bureaus.
Navigating the intricacies of the credit world is easier than most people think. Understanding how to manage different types of credit and determining what best fits your situation is essential to managing your finances.
121 Financial Credit Union can make your life easier by offering various credit options that fit your needs and budget. Contact your staff today to discover your personal options.