types of credit accountsWhile nearly all consumers borrow money in some way, it’s likely that many might not know or understand the differences between the accounts they have open. Although you might think they don’t matter, knowing the differences between an open credit account and a revolving credit account could help you plan your finances, including what kind of credit is best for your needs, and improve your credit scores. That’s why we’re going into detail about the various types of credit accounts available to consumers and why they matter.

Spoiler: Your credit accounts aren’t all the same

You are probably familiar with many of the sources of financing that consumers can choose from when they want to borrow – things like credit cards, personal loans and lines of credit – but when we talk about account types, we’re referring to something different. Credit account types refer to the nature of the borrowing relationship, as defined within the account’s terms. Some accounts allow you to have continuous access to credit, albeit with maximum spending limits, while others might grant you a lump sum of money that has to be paid back in installments. The type of credit account you have may also define the terms and conditions of defaulting, as well as when exactly accounts can be closed.

Breaking down the different types of credit accounts

When consumers borrow, regardless whether they’re asking for a credit card or a loan, the account they open will fall into one of the following types:

  • Revolving accounts are those that allow you to borrow up to a predetermined limit (referred to as a credit limit) that can potentially be increased over time with responsible payment behavior and maintaining good credit. These accounts can stay open as long as your account remains in good standing, which is usually maintained by paying at least a minimum amount of the total balance every month – an action which causes your total available credit to revolve from month to month. If this sounds familiar, it should, as credit cards are the most common type of revolving account that people will come across.
  • Installment accounts are less flexible than revolving accounts, as the borrowed amount is usually given all at once as a lump sum. Additionally, installment accounts tend to have set payment schedules by which the principal, or borrowed amount, is expected to be paid off. For example, you might receive a 24-month loan term, which means you’ll be making 24 payments that are calculated with the APR applied ahead of time so you know exactly how much to pay each month. While these time schedules can be reduced by paying more than your minimum amount, they’re usually not extended. Most types of loans are installment accounts, including personal loans, auto loans, student loans and mortgages.
  • Open accounts are sometimes considered a hybrid of revolving and installment accounts. These accounts are revolving in the sense that they can remain open as long as your account is in good standing; however, unlike with revolving accounts, outstanding balances have to be paid off in full at the end of each billing cycle or you risk default. Usually services like utilities behave this way, as you have a revolving account for which the payment amount differs month to month and you must pay in full at the end of the month. Charge cards are another example of this type of account.

Note that you might see some credit accounts referred to as secured or unsecured. This is technically not a type of credit account, as any of the credit account types we’ve discussed can be classified as one or the other. For example, a car loan is a secured installment account that uses your vehicle as collateral if you’re no longer able to make payments. Revolving accounts can also be secured; just like a mortgage, a Home Line Equity of Credit (HELOC) is a revolving account that claims your home as collateral if you default. In the instance you default, the lender will take your possession(s) to recoup any lost value. Secured credit cards also function in this manner, as you put down a cash deposit to open the account that acts as collateral if you ever default on payments. Unsecured loans, on the other hand, do not require this.

Why does your credit account type matter?

As a consumer who likely has at least one of these credit account types, you might be wondering why it matters. While no one will quiz you on this information, it can be important to your overall financial planning for several reasons:

  • It’ll help you determine your debt repayment strategy. If you need to pay down debt, it helps to understand the consequences that’ll lead you to default for each of your accounts so you can avoid them. Furthermore, when taking on debt in the first place (or adding more to what you’ve got), knowing the type of account you’re opening will help you make sense of the financial burden you’re taking on and plan an effective strategy for repayment.
  • Your ratio of accounts impacts your credit scores. The FICO credit scoring model partly relies on something called a credit mix, or the ratio of borrowing account types, you have open. Your credit mix is approximately 10% of your credit scores, and having a good balance of revolving, installment and open accounts can slightly improve your scores, as it shows that you’re capable of handling multiple types of credit. This means you should understand what type of credit accounts you have and recognize what credit types your credit history may be lacking before you apply for any new credit.

The types of credit accounts may be confusing, but it’s important to understand, among other credit aspects. Keep reading our personal finance blog, where we shine light on the information you need to help improve your credit and overall financial health.