Choosing the Right Type of Credit Based on Your Needs

So much of American financial culture revolves around credit.

Having a good credit score can help you get a loan to purchase things you may not have the cash for and aids in leveraging a favorable interest rate. With so many types of credit available, how does one know the right option to best fit their needs? Luckily, determining the right type of credit for you isn’t as tricky as you may think. We’re here to break down the differences between revolving and installment credit, as well as help you learn about available lending options and when to consider each of them.
 

What are the different types of credit?

• Revolving – Revolving credit is funds you can use freely and repeatedly as long as the account remains open and in good standing. This type of credit automatically renews itself as the balance is paid. You can borrow up to a certain amount of money based on the credit limit for which you have been approved and can pull from this line of credit as desired. With revolving credit, you only pay interest on the funds you actually use. Popular examples of revolving credit include credit cards, department store cards, and home equity lines of credit (HELOC).
• Installment – Installment credit is funds you are granted up-front, in a lump sum, and you agree to pay back on a routine, fixed payment schedule for a specified amount of time. Unlike revolving credit, installment credit does not continuously renew itself after the debt is paid. You will pay back the borrowed money with the addition of interest, and when completed it will be considered paid off and the loan account will close. Popular examples of installment credit include auto loans, mortgage loans, and personal loans.

Should I choose revolving or installment credit?

Both revolving and installment credit have their advantages and disadvantages. The right type of credit for your unique financial situation largely depends on what you’re planning to do with the borrowed funds. Responsibly managing a mix of credit products in your name – such as a mortgage or auto loan combined with a couple of credit cards – can help show lenders you are an ideal candidate for lending. Not all debt is bad debt, just remember to make payments on time and not to accrue more debt than is financially wise. Below, we’ll walk you through different credit options and when they might be the right solution.
 

Credit Card

Credit type: Revolving
When to use: Day-to-day expenses you know you can comfortably pay back or emergencies

A credit card is a card that can be used just like a debit card; however, instead of the funds being deducted straight from your bank account, they are taken out of your credit line. With a credit card, a lender will assign you a credit limit and you can borrow as you please up to that limit. Instead of borrowing a one-time lump sum of cash, a credit card allows you to spend the money you have borrowed, pay it back (with interest), and then borrow again as you see fit.

If you are looking to finance a larger purchase, a credit card might not be your best bet. Interest rates for this product are generally higher than other options. If you pay the entire balance prior to the due date each month, you may avoid interest fees altogether.

When used responsibly, credit cards can help you build credit and allow you to earn rewards for day-to-day spending. Rewards typically include cash back, travel benefits (airline miles, hotel stays, etc), or rewards points.

 

Home Equity Line of Credit (HELOC)

Credit type: Revolving
When to use: Home renovations, life events, financial emergencies, debt consolidation

A home equity line of credit allows you to borrow against the equity you’ve built in your home. The average HELOC extends over a 10-year draw period, giving you the financial flexibility to borrow up to the limit but only charging you interest on what you actually borrow. After the draw period is over, the repayment period begins and you will have to repay the loan in full over time, usually 20 years. It’s wise to make payments regularly throughout the draw period, so you are not stuck playing catch up during the repayment period.

The interest rates on home equity lines of credit are generally low er than credit card rates, making them an ideal option to finance expensive life events or help pay for home renovations.

 

Personal Loan

Credit type: Installment
When to use: consolidate debt, help cover moving costs, make necessary home improvements, cover unexpected financial emergencies

A personal loan is a loan that borrowers can use for a variety of purposes. Often the approval process is quick, and some banks offer same day funding. Since this product is installment credit, you will make monthly payments to the lender until the loan is paid off after an agreed-upon amount of time. These payments will include interest payments on top of the principal.
While it’s possible to use a personal loan for virtually anything, that doesn’t always mean it’s a smart financial decision to do so. Personal loan interest rates can be high, so they shouldn’t be used to purchase vehicles or other items that can be financed with lower interest rates. When used wisely; however, personal loans can help improve your financial situation or provide necessary financial aid.
 

Mortgage Loan

Credit type: Installment
When to use: home purchase, refinance an existing mortgage loan

A mortgage is a loan used to purchase a home or to refinance an existing home loan. Like other conventional installment loans, you agree to make monthly payments to the lender until the mortgage is paid off after a set number of years. In exchange for borrowing the funds, you will be required to sign a contract agreeing the home will be used as collateral for the loan.

Understanding mortgages can be a bit tricky as there are many different types of mortgage options available to potential homebuyers. If you are considering buying a home, talking with a mortgage banker about your homeownership goals might be a good place to start. They can talk with you about your loan options and different down payment strategies.

 

Auto Loan

Credit type: Installment
When to use: vehicle purchase

If you want to buy a vehicle but don’t want to pay for it out of pocket, or maybe you don’t have the cash, then an auto loan may be for you. An auto loan is a lump sum of money granted to a borrower specifically for the purchase of an automobile. You will make payments back to the lender to pay the vehicle off within a pre-determined amount of time. The sooner you agree to pay your loan back, the less you will pay in interest charges.

Auto loans typically have low interest rates, generally as low as 2 or 3 percent, depending on your creditworthiness. So, if a vehicle purchase is in your future, definitely consider financing your car or truck with an auto loan. Like other lending products, making payments on time consistently throughout the entirety of the auto loan can also help strengthen your credit score.

 

What is the difference between secured and unsecured credit?

There are many differences between secured and unsecured credit, but the most prominent is secured credit requires collateral, such as a home or a monetary deposit, to receive financing. Whereas unsecured credit is not guaranteed by any asset, secured loans and credit cards are guaranteed by collateral which can serve as “insurance” for the lender, should you not be able to pay the borrowed funds back.

A secured credit card might be an option if you are looking to establish credit history or improve your credit score. They function like a regular, unsecured credit card, but they require a cash deposit to serve as collateral. Often times, after you’ve proven to handle a secured credit card responsibly, your lender will reevaluate you for an unsecured card.

Choosing the right type of credit for your financial needs doesn’t have to be a stressful experience. Whether you are looking for a new home, purchasing a new appliance, or looking for a way to get rewarded for day-to-day spending, we are here to help. At SouthState, our bankers strive to help you achieve your financial goals. Find a local branch near you or contact us today.

About the Author: Lasheka Murray has been in banking for over 11 years. She has held Branch Manager positions for multiple banks and has led four successful teams during her time at SouthState bank. She has been the recipient of the Gold Path Award as well as the Regional Team Player award. Lasheka enjoys spending evenings and weekends with her family.