Which Is Worse for Your Credit, Unsecured Debt or Revolving Credit?
Carrying too much debt of any kind isn’t good for your credit score, especially if you don’t make your payments on time. When you overextend yourself, lenders and creditors are more likely to consider you a bad credit risk. But if you handle credit responsibly and avoid having negative information listed on your credit report, you can raise your credit score regardless of whether your debts are secured or unsecured revolving credit accounts or installment loans.
Credit Card Debt
Credit card accounts are a form of unsecured revolving debt. Unlike installment loans that give you a definite loan term in which to repay the debt, you can add to the balance again as you pay it down. In an article for MSN Money, personal finance columnist Liz Weston points out that your credit score will increase when you pay down revolving debt. Credit scoring models consider revolving debts -- particularly unsecured credit card balances -- a higher risk. Weston suggests spreading credit card debt over several cards instead of carrying a high balance on a single card. Keep all revolving credit balances low. Otherwise, high debt can lower your credit score.
Home Equity Line of Credit
A home equity line of credit, or HELOC, is also a form of revolving credit, but in this case, the debt is secured -- with your home serving as collateral. With a HELOC you can borrow up to a maximum line of credit for which you are approved based on the amount of equity you have in your home. Although you pay a lower interest rate than you do for credit cards, you put your home at risk in case of default. When you first add a HELOC as a new account, your credit score will drop. Opening a new account makes the average age of your other credit accounts younger, which credit scoring company FICO sees as an indicator of higher risk. Your score will improve as you make on-time payments and pay down the balance.
As with credit cards, a personal loan is an unsecured debt. If you have a good credit history, though, you could pay less in interest on a personal loan than you do on a credit card account. Taking out a personal loan to pay off your credit card balances can give your credit score a boost, notes Bankrate adviser Don Taylor. Installment loans add to your credit mix, which makes up 10 percent of your credit score. Lenders want to know that you can manage different kinds of credit accounts at the same time. Although you can secure a personal loan with collateral, which will qualify you for a lower interest rate, making late payments will drop your credit score and put you at risk of losing the asset that secures the loan.
Effect on Credit Score
When it comes to revolving lines of credit like HELOCs and credit card accounts, a low credit utilization ratio looks good on your credit profile. In addition, a HELOC adds a new line of credit, which lowers your overall revolving credit utilization by increasing the total of your available credit. You can help raise your score by keeping your HELOC balance low and not borrowing more money than you need, Craig Watts, FICO's public affairs director, notes on the Bankrate website. If you borrow close to the loan limit from the start, a HELOC can lower your credit score. Likewise, you should keep credit card balances 10 to 30 percent below the maximum credit limit.
- MSN Money: Raise Your Credit Score to 740
- myFICO: How to Repair My Credit and Improve MyFICO Credit Score
- Bankrate: Restructure Debt With Personal Loan?
- myFICO: What’s in My FICO Score?
- Bankrate: HELOC Activity May Affect FICO Score
- Nolo: Home Equity Loan and HELOC Basics
- Mortgage Professor: Does a HELOC Adversely Affect Your Credit Score?
Amber Keefer has more than 25 years of experience working in the fields of human services and health care administration. Writing professionally since 1997, she has written articles covering business and finance, health, fitness, parenting and senior living issues for both print and online publications. Keefer holds a B.A. from Bloomsburg University of Pennsylvania and an M.B.A. in health care management from Baker College.