How Different Types of Debt Impact Your Credit
You might think of debt in a negative way, but not all debt is bad. If you’ve never had any debt, you don’t have a payment history, and potential lenders have no way of knowing how well you’re likely to handle borrowed money. Borrowers with no credit history are often considered as risky as someone who has a history of making late payments. Let’s consider how different types of debt impact your credit.
Installment loans include any loan that has a fixed amount that you pay every month for a certain number of months or years. This includes student loans, car loans, personal loans, and mortgages. By having a fixed monthly payment, you know exactly how much you need to budget for each month. Interest rates on installment loans are usually lower than on revolving accounts. When you apply for new credit, a potential lender will be able to tell how much longer you have to make payments on an installment account and will consider that when determining if you can handle additional borrowed money.
Revolving accounts such as credit cards and home equity lines of credit allow you to re-borrow money after you’ve paid it back. You have the flexibility to borrow up to the full amount of the line of credit if you need to, but it helps your credit score to keep the balance low, preferably under 30 percent of the total line. You’re expected to pay a minimum payment for each month and it’s up to you to be responsible about planning to pay back what you’ve borrowed in full.
Credit cards are fairly easy to qualify for and the rate may be high since the debt is typically unsecured. While you’re only required to pay the minimum payment, the longer it takes you to pay back the balance, the more you’ll pay in interest. A higher balance means a higher minimum payment, so it’s important to avoid borrowing more than you can afford to pay back.
Credit mix has a small influence on your credit score. This refers to the different types of accounts you have. Having a diverse portfolio of accounts such as a credit card, car loan, student loan, and mortgage can be beneficial to your credit since credit scoring models consider the different types of debt you have and how well you manage each of them.
Potential lenders also look at your total debt and how your debt compares to your income, which is known as the debt-to-income ratio. To borrow responsibly, keep your debt-to-income ratio low. Know what you owe and don’t keep borrowing if you’re having trouble making payments.
Protecting Your Credit
No matter what type of debt you have, the most important thing to do is to make your payments on time. To be sure you don’t forget to make payments on time, you may want to set up automatic payments or put a reminder in your phone when bills are due. Avoid borrowing more than 30 percent of your credit limit on credit cards.
Keep an eye on your credit reports and make sure there isn’t incorrect information being reported. Wrong balances or wrong payment statuses can bring down your credit score and make it harder for you to get approved for credit at the best rates in the future. Dovly is an AI credit engine that can dispute errors for you and help you track, manage and fix your credit. Try it risk-free with our free membership tier.