Many consumers don’t make a strong connection between installment loans -like auto loans, student loans, and mortgages- and their ability to help them qualify for revolving credit cards issued by VISA, MasterCard and American Express. The banks that issue that plastic do factor in your installment loan history when you apply for a credit card.
The really big surprise for most consumers is that not having any installment loans can influence your chances of getting approved for a credit card, including your line of credit if approved. That recently happened to someone I personally know who has a rather enviable credit score of about 760. They were turned down for a credit card they wanted and part of the reason cited by the bank was that they had an “insufficient recent installment loan history.” In other words, they paid off all the debt a while back and now it has come back to haunt them. Yes, low debt is a good thing, but zero debt can be an impediment to borrowing.
Installment Loans vs. Revolving Credit
It’s important to understand the difference between installment loans and revolving credit, and how they can complement one another in terms of your overall borrower profile and ability. Installment loans are-as their name implies- repaid in installments or regular increments over time. One of the best examples of an installment loan is a home mortgage. You buy a house, take out a home loan, and then make payments each and every month until the balance is repaid in full. Your payments may be based on a variable or a fixed interest rate, and depending on which kind of loan you have, your payments may stay the same month in and month out, or they may vary. What doesn’t change is the requirement for you to make a timely payment each and every month.
Revolving credit, on the other hand, fluctuates with your borrowing patterns. Sometimes you borrow a lot, so your credit limit shrinks. When you repay what you’ve borrowed it goes back up again and you can use more of your available credit. In this way, the money you are borrowing is on a cyclical schedule that revolves around your use of the credit. The most common kind of revolving credit is a standard, conventional credit card with no annual fee. The card company gives you a certain amount of credit and if you never use the card, you never have to make a payment. When you do use it though, you can either pay it back right away or over time, by carrying the balance forward from month to month.
When Having No Debt Harms Your Credit
Of course we all know that paying back loans is the right thing to do. Before lenders loan you money or extend credit to you, though, they want to have some way to predict whether or not you’ll repay what you borrow. The best way to gauge that is to look at how you’ve handled your previous debt repayment obligations – which is why lenders love to peek at your credit history, credit report and your credit score. What happens when creditors examine those things and find no history at all? They tend to shy away from loaning to you, because they have no real way of judging your credit worthiness with traditional yardsticks like credit reports. That may seem contradictory and unfair, but it’s the way things work in the financial world. With no credit history, nobody will offer new credit, yet without new credit being offered, there’s no way to prove they are responsible for repaying their loans. They are stuck in a “Catch 22.”
How to Establish New Installment Loan Credit
Getting out of such a predicament is not too difficult, however, although it does require some deliberate steps and a little bit of financial patience and planning. The best way is to begin with a basic installment loan that you can easily repay in a timely manner. Even if a credit card is your ultimate goal and you don’t really need an installment loan, it’s still the path of least resistance toward breaking down the barriers to credit worthiness and bank or lender acceptance.
First, open a bank account and develop a relationship with one particular bank and then talk to a loan officer. Tell them you are trying to establish good credit, and ask them if you can borrow using an installment loan. They may approve your request right away, but if not, ask them to guide you through the necessary steps to help you get you qualified. Once you are eligible be sure to pay it back gradually, on time, and according to the terms of your agreement. Also, make sure the bank reports your payment history to the “Big 3”agencies; otherwise, your efforts to build history are useless.
One Good Turn Deserves Another
As you gain a history in installment loans, that improves your chances of getting revolving credit. You can significantly improve your chances of qualifying for an installment loan by establish revolving credit. The takeaway lesson here, however, is that one without the other can weaken your position. To have strong credit, you will want to have a long history of both, and responsibly maintain both kinds of borrower history and reputation.
So, don’t be afraid to take out an installment loan or carry a credit card. Even if you don’t use them, they are your best tools for building stronger credit. Just make sure that you use them wisely and strategically to bolster your borrower image.
Tom Kerr writes for the blog at Comparecards.com in addition to others. He has been an avid writer for years, even winning awards for work he’s done.