3 Ways Installment Loans Affect Your Credit Score
Your credit score has more of an effect on your life than you might think. While its primary use revolves around proving that you're responsible enough to pay on your existing debt obligations and show your creditworthiness, it has evolved over time for additional uses. When you check into new insurance rates, look at apartments or send in a job application, you run a high likelihood that your credit gets checked during this process. It's important to know exactly how your lines of credit affect your credit score and how your credit can be the best it can be.
What are Installment Loans?
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Installment loans, such as personal loans and student loans, are a line of credit that gives you the entire amount you're qualified for at the beginning of the loan. You pay it back in equal installments over the life of the loan, with a fixed or variable interest rate. Unlike credit cards, you cannot pay down the balance and open up additional funds for use. Once you've acquired the money from this line of credit, you do not receive any additional funds.
An installment loan adds another line of credit to your credit report. When you're first establishing yourself with a credit score, you want to have several lines of credit. Credit diversification is a positive factor on your credit score, so having an installment loan alongside a credit card is sometimes better than having two credit cards. Unlike credit cards, you don't have a loan utilization factor that changes your credit score based on the amount of credit you're using from the loan. This allows you to avoid large score fluctuations that are associated with credit card utilization factors.
Other Factors Controlling Your Credit Score
Another big factor in credit scoring is how long you've had credit. When you add an installment loan to your credit portfolio, established credit users see a temporary score decrease as the new account lowers the overall average age of your lines of credit. Generally, if you have many positive trade lines on your report that are well-aged, your score recovers within a few months, and the impact is not particularly large. If this is the first installment loan you added to your credit report, you're likely to see a positive boost due to the credit diversification factor previously mentioned. When you pay off an installment loan, the account remains on your credit report, helping increase the overall age of your accounts as the years pass.
Your credit report acts as a way for lenders to see your payment history over the past two years. On time payments are a big deal for your credit score, accounting for 35 percent of your credit scoring factors. When you pay your installment loans on time, you have another positive tradeline on your report. When you miss one payment in a 30-day period, you see a significant credit score drop, but you don't remain affected by it for long. Most lenders overlook a single 30-day late payment, as sometimes technical difficulties get in the way of payments going through, or you simply forget. A 60-day late is much more significant to your score, and the effects last for some time. A 90- or 120-day late are as bad as a collection account, and many creditors charge off accounts at that point or send them to collection agencies. If you miss a payment or have trouble paying installment loans, talk to your creditors to determine the options available for you to get caught up.
Installment loans are an important addition to your credit portfolio. Whether you have a personal loan, auto loan, student loan or another installment loan type, you expand the types of credit you have, you build a tradeline with a positive payment history and over time, you have an aged account for your credit score.
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