Installment Credit vs. Revolving Debt: Which Should You Pay Down First?
Several factors influence your credit score, including how much debt you have. At the same time, the type of debt you owe also matters. Generally, debt is categorized as installment credit or revolving debt.
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Understanding how they differ â€” and how they impact your credit score â€” can help you decide which one to tackle first, if debt freedom is your goal.
Installment credit vs. revolving debt: What’s the difference?
Installment credit is debt that you repay on a fixed schedule. You make a set number of level payments over time, usually with interest, until the balance reaches zero. Examples of installment credit include auto loans, student loans or a home mortgage.
Revolving debt, on the other hand, is a little different. With an installment loan, you can’t add to the balance; you can only pay it down. Revolving debt, such as a credit card, personal line of credit or a home equity line of credit (HELOC), allows you to make new charges against your line of credit. And, as you make payments each month, you free up your line of credit. There’s no specific end date by which you have to pay the account in full. Instead, you’re only required to pay at least the minimum amount due by the payment due date each month.
Installment credit, revolving debt and your credit score
Installment credit and revolving debt can impact your credit score in different ways. With the exception of student loans and personal loans, installment credit is typically tied to some form of collateral, such as a vehicle or a home.
Revolving debt is usually unsecured. The lender may assume a greater degree of risk with this type of credit because, if you stop paying, there’s no collateral they can claim to recoup any losses. Revolving debt also tends to carry more weight in credit score calculations.1
There’s a reason that revolving debt can more readily affect your score. The various credit scoring models factor in your credit utilization to determine your score. Your credit utilization ratio simply means the percentage of your total credit line you’re using at any given time.
Using more of your available credit can be harmful to your credit score, while keeping your revolving debt balances low can be beneficial. For that reason, maxing out a revolving credit card or line of credit may have more of a detrimental effect than carrying a large balance on an installment loan.
Which debt should be paid off first?
Understanding how installment credit and revolving debt differ can help you decide which one to prioritize paying off first. It’s also helpful to consider the financial implications of choosing one over the other.
Paying down your credit cards or other revolving debt first may be a good option if you’re focused on raising your credit score. Knocking out your revolving balances could improve your credit utilization and translate to a higher score. That’s important if you don’t own a home, but you’d like to at some point. The better your score is, the better your chances of being approved for, and securing a favorable rate on, a mortgage.
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Regardless of whether you choose to pay off your installment or revolving debt first, there’s one thing to remember: Always pay on time. Late payments can be very damaging to your credit score, so it’s important to stay on top of your due dates and pay on time each month.