As far as finances go, everyone who seeks credit has specific varying needs and financial capabilities. To address this, credit companies and financial institutions have designed and developed various credit accounts to cater to the different demands of consumers. In this article, we’ll talk about the different types of credit, how loans and mortgages are divided into categories, and how these can affect your credit score in the long run.
What Are the Different Types of Credit Offered Today?
Financial institutions, such as banks and credit companies, offer users two primary types of credit: revolving and non-revolving. These two categories mainly differ on how credit is paid, how accounts are set up, and what happens after repayment. When financial institutions request your credit reports or if you plan on learning how to check your credit score, these main credit types will be included in the credit score equations. These play significant roles in your credit history and can make or break your financial identity every time a financial institution processes a new application for a new line of credit.
What Is a Revolving Type of Credit?
To better understand the difference, let’s first focus on what revolving credit is.
Revolving credit is the kind of credit that allows borrowers to borrow and repay the money over time. With revolving credit, the borrower can access a certain amount of money they can use for different purchases. The borrower can borrow up to the limit if they have not reached their credit limit. The borrower then pays it back by making regular payments until their balance is paid off. Some of the most common types of revolving credit offered by lending companies today include:
Credit Cards
Credit cards are one of the more well-known types of credit banks offer. A credit card is a payment card issued to users as a payment system, which cardholders can use to buy goods and services based on the holder’s promise to pay for these items. A credit card is an example of a type of revolving credit, meaning that the credit limit is continually renewed monthly or as needed up to an agreed limit with the issuing bank.
Home Equity Lines of Credit
A home equity line of credit (HELOC) is a type of non-secure credit that a borrower can use to borrow money depending on the value of their home. This is often done by tapping into the equity they have built up on their property. Borrowers will take out a fixed amount, which will be repaid at set intervals over a given period.
The interest rate for this type of loan is usually variable, and borrowers will need to pay back the full amount borrowed plus any accrued interest.
- Deposit Accounts With Overdraft Protection
Overdraft protection is a kind of credit service that a bank offers to its customers. It is an account with an overdraft limit or line of credit. When a customer uses their overdraft protection, the bank will cover any transactions exceeding their account balance up to the limit.
- Margin Investment Accounts
Margin investment accounts are a type of brokerage account credit that allows investors to borrow money from the brokerage firm to buy securities. These accounts are typically used by investors who want to speculate with higher amounts of money than they have in their accounts.
Aside from these types of revolving credit, some financial institutions also offer two other categories of revolving credit, secure and non-secure. These two types differ mainly regarding the use of collateral to safeguard the financial institution’s integrity. Here are their main differences:
Secure Revolving Credit
Secure revolving credit refers to a line of credit that is secured by collateral – whether through an outright cash deposit, a vehicle, real estate property, or any valuable items owned. Creditors typically use this as a type of guarantee to ensure that applicants will pay off their lines of credit. If their loans default, financial institutions can seize the property as payment. Because of this assurance, secure revolving credit typically has lower interest rates.
Non-Secure Revolving Credit
Non-secure revolving credit refers to a line of credit not secured by any type of collateral – giving financial institutions higher risks of loan default. Because this typically entails higher financial risk for credit companies, non-secure revolving credit is often offered with higher interest rates.
What Is a Non-Revolving Type of Credit?
The other type of credit that financial institutions offer is non-revolving credit. Non-revolving credit is a type of credit that does not have a fixed repayment schedule. Instead, it is usually used for purchases that are made on an as-needed basis.
Non-revolving credit can be used for anything from buying groceries to paying for a vacation. The only requirement is that the borrower pays back the amount borrowed plus interest when they can do so. Some of the most common types of non-revolving credit include:
Mortgages
A mortgage is a kind of credit used to purchase real estate property. The borrower pays back the loan with interest over a set period. The borrower can make monthly payments or pay off the entire mortgage at once. Mortgages are usually repaid over 15-30 years, but some mortgages can be repaid in as little as ten years. The borrower will have to pay more in interest if they choose to repay the mortgage over a shorter amount of time.
Auto Loans
Auto loans are a type of loan credit offered by banks to assist individuals to purchase a car or any type of vehicle. Auto loans can be used for the purchase of new or used cars, as well as for the refinancing of an existing auto loan. These are typically repaid over a period of five years or more, with monthly payments that vary depending on the size of the loan and the interest rate.
Student Loans
Student loans are a type of credit students take out to pay for their education. They can be taken out from the government, private lenders, or a combination of both. Student loans can be used to pay for tuition, books, and other educational expenses. They are usually repaid after graduation when the student gets a job and starts making money. The interest rates on student loans vary depending on what type you take out and whom you borrow from. Some have variable rates while others have fixed rates.
Does Having Different Types of Credit Affect Your Credit Score? How and Why?
When it comes to your credibility as a borrower, your credit score trumps all other factors in determining your reliability and financial stability. Banks, credit companies, and loan enterprises typically depend heavily on your credit score to see whether you’re a low-risk individual regarding finances. Therefore, maintaining a good credit score is absolutely crucial for achieving financial independence and allowing financial institutions to process your applications and offer competitive interest rates.
Unfortunately, numerous factors can affect the results every time a credit company calculates your credit score – including the types and amount of credit you currently have. While owning multiple credit cards is legal and is typically not frowned upon, you can incur higher risk when it comes to your credit score. If you’ve currently applied for new lines of credit and you’re now thinking about whether this may affect your credit score, here are a few situations that you may fall under:
- You have opened multiple credit accounts within a short period of time
While there is nothing wrong with credit applications per se, every new credit application is reflected on your credit report, regardless of whether they’re approved or not. The higher the number of credit applications, the more negative effect it has on your credit score since these signals to financial institutions that you’re consolidating more debt.
- Your debt-to-credit ratio is higher
When it comes to having credit – whether through credit cards, personal loans, or any other type of credit – financial institutions look at your debt-to-credit ratio to see how much debt you’re willing to have within a certain time period. Unfortunately, even though you have paid your debts on time and never miss a payment, a high credit utilization rate will still affect your credit report and may cause your credit score to drop – especially if you have multiple maxed-out credit cards at any given time.
- You have a poor history of credit payments
Having more credit accounts means a higher risk of payment errors during deadlines. Unfortunately, poor history of late payments, defaults, and penalty interest rates may cause your credit score to drop.
- You have more hard inquiries about your credit score and report
Each kind of credit application you submit to financial institutions is recorded in your credit report, especially since credit companies make hard inquiries each time an application is submitted. While soft inquiries do not affect your credit score, hard inquiries that are required by credit companies may affect your credit score.
All these behaviors can harm your financial stature and cause lower points when you check your credit score – reducing your chances of being approved for any other credit application you’re planning to submit. However, while these behaviors are harmful, many credit applications are denied year after year because of one reason: a lack of credit history.
How Alternative Credit Scoring Can Help the Unbanked or the Underbanked
Around the world, there are millions of people who are considered “underbanked.” This means that they don’t have access to traditional banking services, such as checking and savings accounts, as well as the different types of credit. This has proven to be a challenge, especially when it comes to things like getting a job or renting an apartment. Without a bank account or a credible credit history, it can be difficult to prove your creditworthiness and get approved for a loan or other type of credit.
However, to answer this, financial institutions are now starting to adopt new ways to calculate credit scores from alternative data – a new system that can help the underbanked and the unbanked gain access to different kinds of credit even in the absence of a credit history. Alternative credit scoring uses a variety of data points, such as utility bills, rent payments, and even social media data, to create a credit score. This can help people who don’t have a traditional credit history to get approved for loans and other forms of credit.
Alternative credit scoring is still in its early stages, but it has the potential to help millions of people around the world. This is what FinScore aims to offer Filipinos. With the majority of Filipinos now with access to telecommunication services, financial institutions can tap into alternative credit data from telecom companies and use relevant information to determine a person’s creditworthiness even when these people have not had access to formal banking.
Have queries or questions about how alternative credit scoring works? Send us an email at FinScore and we’ll help you understand how it can revolutionize the finance industry.
