Most people believe that, when it comes to debt and credit, all debt is created equal. They think that mortgage debt is categorized in the same way as credit card debt and that, the reason mortgages are harder to get than credit cards is because of the amount of money being loaned is larger than that of a typical credit card. This is not true.
There are several different types of credit and loans that a person can apply for and obtain. Each of those different types of credit is weighed differently.
Installment accounts are sometimes called “closed end” accounts. These are loans or lines of credit that come with a definite “pay in full by X” date. The most common types of these loans are mortgages, car loans and student loans. These are weighed heavily on your credit score and are scrutinized by banks and other creditors and lenders because they tend to be larger. The larger the loan the more your debt to income ratio comes into play. How you perform with one loan could very well determine whether or not you are approved for the same type of loan in the future.
Revolving accounts are often called “open ended” accounts. These are credit cards, store lines of credit, etc. These are debts that can be carried, well, forever if a person manages them well. Unlike a mortgage which is for a set amount and that must be paid in full, with every payment working to bring the loan amount to zero, a credit card is more flexible. A line of credit can be increased or decreased and every payment made goes (after interest payments) toward restoring the amount of credit available to the credit holder.
These are also very closely scrutinized by banks, lenders and creditors. In fact, the credit bureaus and other lenders/creditors often give these types of loans and lines of credit more weight than the larger installment plans like mortgages and student loans.
It’s All About Collateral
When you take out an installment loan, it is usually to get something incredibly valuable like a home or a car (an education is the exception that proves this rule). If a person fails to pay these loans properly and on time, they risk losing that possession. Defaulting on a mortgage will result in foreclosure and having to find a new home. Defaulting on an automobile loan will result in having the car repossessed. Because of this, most borrowers make installment loans their highest priorities. They almost always pay these properly because they don’t want to wind up homeless or without a means of transportation.
Revolving accounts, on the other hand, are the first to be put off in favor of installment plans, food, and other expenses. While people’s intentions toward them might be good, they rarely fly into a panic at the idea of being a few days late on a payment.
For many banks and creditors, it is how people handle these “optional” payments that tells them what they need to know. If a person has a perfect record on their mortgage but has a dozen credit cards in collections, they are unlikely to be approved for future loans and their credit scores will likely be low. They may be so low that getting even small unsecured lines of credit become impossible.
This is when, if you are in financial trouble you might be tempted to turn to two other types of loans. One of these will have an impact on your credit score, the other likely will not.
PayDay loans are predatory loans. They are short term loans that come with outrageously high fees and terrible interest rates. They are designed to keep borrowers dependent on them for survival. For example, taking out a $50 PayDay loan will usually cost you at least $75. $50 goes to pay back the loan and the other $25 is for the fee you pay for the “privilege” of short term borrowing. If you fail to pay the loan back on time, the lender will likely tack on another $25-$50 or even more on top of what you already owe. So, even if you are just a day late, you could wind up paying $125 to borrow $50. Many states have banned PayDay loan companies from operating within their borders because of the lenders’ predatory practices.
Consolidation loans, on the other hand, are usually viewed the same as any other installation agreement…if you apply for and use them privately. A consolidation loan, when borrowed privately, is usually borrowed as a private loan. Lenders do not care what you used it for, as long as you pay on it responsibly (though they will be able to see how your debt shifts from one account to another).
If you go through a consolidation service, however, this may have an affect on your credit score. This is because credit consolidation companies usually work simply as “middle men.” You pay them one lump sum and then they distribute that payment across your accounts.
A Quick Word About Credit Repair
If you have a lot of loans or discharged debts or credit accounts on your report, that can also be a huge ding against your score. While it is true that very few things stay on your credit history and report forever (like student loans), it is also true that you not have to wait for them to fall off naturally. Some people work with their previous creditors and lenders to have closed accounts removed from their records. According to a video from the Creditrepair.com YouTube Channel, some people have great luck hiring a credit repair service to help them get rid of mistakes and other bad data–like an installation agreement that has been classified as a revolving account, which can help raise their credit scores and improve their credit histories.
Understanding the difference between the different types of loans and credit is a big part of solving your credit score puzzle. Use the information contained here to help you get started!