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Their Impact on Your Credit Score

While both installment and revolving debt are factors, the latter has a greater impact on credit scores. Managing revolving debt can be crucial to your score.

• • Revolving debt, primarily credit cards and lines of credit, impacts credit scores in two main ways: payment history and credit utilization, which is the amount of available credit you’re using. Keeping credit utilization low—ideally under 30% of your credit limit—positively affects your credit score. Borrowing close to the limit can lower your score, while missed and late payments can significantly lower your credit score. 
  • Installment debt, while not as impactful as revolving debt, also affects your credit score. This is primarily through your payment history and credit mix. Consistent, on-time payments on installment debt, such as auto and student loans, will reflect positively on your credit score. While credit mix (installment and revolving debt) has a small impact, borrowers who manage this blend will demonstrate creditworthiness, which positively influences their credit score.

Understanding the Credit Score Algorithms

Each of the major credit bureaus uses credit-scoring algorithms to calculate their scores, such as VantageScore and FICO. These algorithms primarily analyze your payment patterns, length of credit history, and credit utilization. While the exact algorithms aren’t known to the public, analysts can estimate the factors the algorithms use and in what proportions. The top-line factors are:

• • • FICO: Payment history (35%); credit balance (30%); length of credit history (15%)
    • VantageScore: Payment history (40%); length & type of credit (21%); percent of credit used (20%).

As the largest part of credit score calculations, payment history has the greatest impact. Just one 30-day late payment could lower a credit score by up to 100 points. If you want to improve your credit score, ensuring on-time payments is the first place to target.

The Pros of Installment Debt

• • Predictability. With fixed payments, usually fixed amounts, installment debt simplifies monthly budgeting.
  • Plannability. With installment debt, you know precisely when the debt will be paid off. This can be essential to long-term financial planning.
  • Compatibility. While installment debt is often less impactful on your credit score, it can serve as the backbone of your credit mix. It supplements revolving debt to contribute to a higher score.
  • Practicality. Installment debt is the go-to option for making large, necessary purchases such as cars and homes.
  • Responsibility. As you pay down installment debt, the balance decreases. This continual reduction of the money owed demonstrates financial responsibility which helps create a positive credit profile.

The Cons of Installment Debt

• • • Rigidity. With the fixed nature of installment debt, you can’t access more money without a new loan.
    • Commitment. A mortgage is often a 30-year commitment; that level of long-term financial obligation could be daunting for some.
    • Interest Accrual. While the interest rate on installment debt is often considerably lower than that on revolving debt, it often has longer terms. That means that installment debt can accrue a significant amount of the total interest paid over time.

The Pros of Revolving Debt

• • • • Flexibility. Borrow what you need, when you need it, up to your credit limit. In many cases, you can raise that limit.
      • Availability. Installment debt usually requires an approval process before you get the money in hand. With revolving debt, it’s much easier to access.
      • Credit Building. On-time payment of revolving debt is the cornerstone of good credit history. Poor payment history—as well as no history—usually damage credit scores.
      • Grace Periods. Credit cards often have interest-free grace periods; timely repayment could mean you pay no interest on the money you borrow.

The Cons of Revolving Debt

• • • • Interest Rates. Credit cards and personal loans usually have higher rates than mortgages.
      • Overspending Risk. With such ease of access, many credit card holders borrow more than they can afford to repay.
      • Credit Risk. Late or missed payments, as well as high balances, risk damaging your credit score
      • No End in Sight. Unlike installment debt with an end date, revolving debt (and the interest you pay on that debt) can continue indefinitely

Before you buy a home…

It’s crucial that both your installment debt and revolving debt are in order. Take these important steps:

• • • • Review Your Credit Report and Score: You can get your credit report from the major bureaus: Experian, Equifax, and TransUnion. Check for errors that are common and disputable.
      • Address Revolving Debt: Tackle credit cards first. Getting the amount you owe under 30% of your credit limit is good; under 10% is significantly better. Consider using the “avalanche” method, paying down the highest interest cards first, or the “snowball” method, starting with the smallest balances.
      • Avoid New Debt: Even a small addition to your debt profile could have a negative impact on mortgage approval. No new lines of credit, no increased use of existing credit.
      • Know Your DTI: Your debt-to-income (DTI) ratio is a significant factor in your mortgage approval and terms. Ideally, you want to aim for a DTI of under 43%. A DTI of under 36% could result in better mortgage terms.

When you’re ready to buy your dream home, we’re ready with the right financing options. Call a member of the Equinox team aWhen you’re ready to buy your dream home, we’re ready with the right financing options. Call a member of the Equinox team at 1-888-505-8960 or connect with us online today.