Credit Score
When it comes to credit, it’s more than just swiping a plastic card. There are many types of credit accounts you can leverage along your financial journey—each with their own purpose, features, and best uses.
To determine which type of credit account is right for your needs, let’s review the three main types of credit accounts: revolving credit, installment credit, and open credit.
Revolving Credit: An Overview
Revolving credit is a type of credit account that lets you borrow up to a certain limit on a recurring basis. As you pay off your borrowed amount, your available credit replenishes, allowing you to borrow again.
Key Characteristics of Revolving Credit
Credit limit: Revolving credit comes with a predetermined credit limit, which represents the maximum amount you can borrow.
Repayment: The repayment of revolving credit is flexible. You’re required to make minimum monthly payments, which is typically a percentage of your outstanding balance.
Interest and fees: Depending on the terms of the account, interest and other finance charges may apply—but you can often avoid these charges by paying your balance in full each month.
Examples of Revolving Credit
Credit cards: Credit cards are the most common form of revolving credit, allowing you to make purchases, transfer balances, and even borrow cash.
Personal lines of credit: Like credit cards, personal lines of credit let you borrow money as needed (up to a specified limit). However, they differ in that they don’t provide funds in a single lump sum.
Home equity lines of credit (HELOC): A HELOC lets you borrow against the equity you’ve earned in your home. It’s crucial to handle this type of credit with care, as your home serves as collateral.
Installment Credit: An Overview
With installment credit, borrowers receive a fixed amount of money that they repay through fixed payments over a certain period.
Key Characteristics of Installment Credit
Loan Amount: With installment credit, you borrow a lump sum of money upfront.
Repayment Schedule: Borrowers typically repay installment credit through fixed monthly payments spread over several months or years.
No Replenishing Credit: Unlike revolving credit, installment credit doesn’t replenish as you pay off your balance.
Examples of Installment Credit
Personal Loans: Borrowers obtain these loans for personal use, repaying them in fixed payments over a specified period.
Auto Loans: Auto loans are used to purchase vehicles and are repaid over an agreed-upon period.
Mortgage Loans: Homebuyers obtain mortgages to purchase a home, often repaying them over lengthy period spanning several years or decades.
Open Credit: An Overview
Open credit, also known as charge cards, is the least common type of credit. It allows you to make purchases like a credit card but requires you to pay your balance in full each month.
Key Characteristics of Open Credit
No Interest: Unlike credit cards, open credit doesn’t accrue interest.
Full Payment: With open credit, you’re required to pay your balance in full each month to avoid penalties.
Understanding the different types of credit accounts is crucial to managing your finances effectively. Whether you opt for revolving credit, installment credit, or open credit, ensure to make informed decisions based on your financial goals and circumstances.
Remember: knowledge is power. The more you understand about credit accounts, the better positioned you are to make sound financial decisions!
This article is for educational purposes only and is not intended to provide financial, tax or legal advice. You should consult a professional for specific advice. Best Egg is not responsible for the information contained in third-party sites cited or hyperlinked in this article. Best Egg is not responsible for, and does not provide or endorse third party products, services or other third-party content.