Do Installment Plans Hurt Your Credit Score?
Installment loans are a popular form of financing that provides borrowers with cash upfront in exchange for fixed payments at a regular frequency. Mortgages, car loans, and personal loans often follow an installment plan format, typically with regular monthly repayments.
When it comes to impacting your credit, installment loans are a double-edged sword. With proper management, they can be an effective tool to improve your credit score over time. But used unwisely, they also have the potential to cause significant damage.
To understand how installment loans can impact your credit, we’ll start by looking at the harm they can cause without proper care.
How can installment loans hurt your credit score?
Unlike credit cards or other forms of revolving credit, installment loans offer little flexibility when it comes to repayment. Although lenders usually extend a short grace period for late payments, you’re required to make your installment payment in full each month.
Missed Loan Payment
If you fail to make a full payment within 30 days of the assigned period, your lender will notify the credit bureaus, and your credit score will take a hit. Payment history makes up the largest portion of your credit score, and even a single missed payment can affect your credit.
Still, a single 30-day late payment is le`ss impactful than payments that are 60 days late or longer. As such, you’ll want to make up for the missed payment as soon as possible. If you continue to miss payments, the loan may eventually go into default and can further drag down your credit score.
Hard Credit Checks
Payment history is the primary way in which installment loans can hurt your credit in the long term, but short-term impacts resulting from applications are also possible. When prospective installment loan providers make a “hard inquiry” on your credit report, you may see a temporary credit score drop of about five points or less.
In addition, a new installment loan can reduce the overall age of your credit accounts, which makes up a small portion of your credit score. As your loan ages, however, this becomes less of a factor.
As long as you’re making on-time payments in full, installment loans will rarely harm your credit in the long run. In fact, they can actually prove quite beneficial to building strong credit.
How can installment loans help your credit score?
When appropriately used, installment loans can be a surprisingly effective tool to improve your credit. By making fixed payments each period, you can develop a strong payment history, demonstrating your diligence and responsibility to future lenders.
Installment loans won’t impact the second-most important factor in your credit score, which is your credit utilization ratio. That ratio only incorporates your balance on revolving credit accounts, from which installment loans are excluded.
An installment loan could improve your credit mix, however. If you only have revolving loans (like credit cards or lines of credit), adding an installment loan can improve the overall diversity of your credit sources. In fact, paying off an installment loan early can sometimes harm your credit if it reduces your overall outstanding credit mix.
Improve Credit Score
Installment loans can be a competitive option for borrowers looking to rebuild or improve their credit. Because repayments are fixed, they’re simpler to budget for, making it easier to build a strong payment history. Moreover, it’s possible to use installment loans as a debt consolidation tool for high-interest debts, providing a more sustainable path out of debt.
Ultimately, installment loans will neither harm nor help your credit on their own. Instead, their credit impact derives entirely from whether you can use them effectively and responsibly.
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