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The Difference Between Installment Loans and Credit Cards

2013/02/25 by

Why wouldn’t you want to pay a loan off early, if you’ve got the money and the ability to do so? The below article written by Deanna Templeton for MSN Money explains how paying off an installment loan, such as a student loan, auto loan, furniture loan , etc. can actually not be helpful for improving one’s credit score. As contrary as it may seem to logic (paying off debt = better credit), there are actually a few proven reasons why paying off an installment loan early will not do anything to better one’s credit, and according to credit scoring models can actually make a consumer less creditworthy. I know it sounds strange, but just read Templeton’s explanation below and you’ll see why the model works this way:

“With credit playing such a huge factor in your financial future, it’s no wonder we look for ways to maximize our credit scores. One common strategy for building your credit scores is to pay off credit card debt. It can give your credit scores a nice boost, especially if you’re carrying a large balance.

It may seem logical, then, to assume that the same strategy must apply to other types of accounts — like a car or home loan, for example. And if you follow this theory, paying a loan off early might sound like a great strategy for building your credit scores.”

Click here to read about the difference between installment loans and credit cards, and why paying off one is good for your credit score but why paying off the other is not so good.

Now, let me just say this, which Templeton does not address in her article: if you are paying high interest rates on your loans, it is obviously a better choice to pay them off quicker. But given that student loans don’t typically carry high interest rates (usually 8% or less,) it’s not such a bad idea to pay the minimum each month and then use the extra money to invest in a business, or a house, or whatever else you may need to set yourself up for success. See, it’s not just about paying off debt quickly or not. It’s about the interest you’re paying, versus the comfort of the life you’re living. You could throw all of your money at a student loan or mortgage payment, and then be left with zero at the end of each month versus paying the minimum and putting the extra money in an emergency fund. Bottom line is that each person has to do what’s right for them, because some people just absolutely loathe the idea of being in debt at all and need to pay it off quickly to feel better. To each his own!

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