When navigating the world of credit, it’s important to understand the different types of credit and how each one works. There are four main types of credit accounts: revolving credit, charge cards, service credit, and installment credit. Each type of credit serves a purpose for borrowers and may impact your credit score in different ways. While revolving credit is one of the more common types of credit issued, you may wonder “what is revolving credit?” This guide will discuss the four different types of credit accounts and their significance to borrowers.
Revolving credit is a line of credit offered by lending institutions that can be used consistently and up to a certain credit limit as long as the account is open and paid on time. With revolving credit, you’ll borrow money from a lender and use the funds when needed. Corporations or individuals can use revolving credit as it may help them with their cash flow needs each month. Some common examples of revolving credit include home equity lines of credit (HELOC), credit cards, and personal lines of credit.
Financial institutions fix the maximum amount for revolving credit when reaching the agreement with the borrower. For individuals, the lender reviews their credit score, current income, and stability of employment. For companies and large organizations, the lender will review balance statements, the statement of cash flows, and the income statement. Borrowers of revolving credit may choose to repay the balance immediately or over a period of time with interest.
While charge cards may be confused with credit cards, they differ in the sense that they require the cardholder to pay the entire balance in full each month. Unlike credit cards, charge cards don’t extend credit to their users. Since charge cards do not allow users to carry a balance, they are not good debt consolidation tools.
Service credit is the number of years an individual has worked that count towards retirement plans such as a pension. Employees generally receive service credit for each payroll period they’ve worked which a retirement fund contribution is made. A person who works for a company for ten years but is only vested in their company’s retirement plan after three years may only have seven years of service credit count towards their retirement fund.
Installment credit is a loan issued for a fixed amount of money. With an installment payment, the borrower agrees to make a fixed amount of payments to a specific loan amount for a set repayment period. This repayment period may be anywhere from a few months to several years until the loan has been paid off.
With installment credit, lenders may need assurance that the borrower will repay them when they issue the loan. When determining the risk that a borrower might bring, lenders consider factors such as credit score, past debt history, annual income, debt-to-income ratio, and current employment. Some of the most common types of installment credits include mortgages, student loans, auto loans, and unsecured loans.
Knowing the four different types of credit can help you better understand what is required when you apply for credit. Understanding how your past financial habits may affect your ability to borrow credit can help you make the adjustments needed to get favorable financing terms later on. Maintaining a good credit history can open doors to future lines of credit with favorable terms when you need them.