2. Revolving vs. Installment Credit

Hello, and welcome to this module. Revolving vs. Installment Credit. So now that you have a really good feel for how to build up a strong credit foundation, you need to understand how these types of tradelines and or credit accounts are going to have an impact and not just building your credit for now, but also putting yourself and your family in position to literally build wealth. But before we can get to that particular place, we have to understand the difference and how to deploy both of these, on that particular credit situations to maximize the outcome that we’re seeking. So here’s what we’re going to cover. So the first thing I’m going to break down is what is revolving credit. Then I’m going to get into the difference in what is installment credit. So that way you understand it. I’m going to break down the types of revolving credit accounts that are available to you.

Then I’m going to break down exactly the types of installment accounts that are available to you, and you may already have both of these types of accounts, but you may not be using them correctly. We’re going to clearly define both of them. So that way, you know, and then there’s something else that’s very, very important for you to understand and that’s debt to income ratio and how this takes into account to your ability to go out and get money i.e in this particular scenario, this is literally the water in the glass so to speak, however, before we can even get to this, we need to get this ratio as well as it relates to these types of accounts and these particular tradelines. So let’s hop right in. And again, if you don’t have a pen and paper, make sure you get one.

Obviously you can come back and go through this particular, this particular module. I’m going to give you some action steps below this to calculate some things, but this is really, really pivotal for you to understand. Okay. So what is revolving credit? This is a really good question. So revolving credit when used correctly is powerful. It is very, very powerful. So revolving credit is access to capital or cash from a financial institution or business in which you have the ability to use over and over again, as long as you pay the balance off, down or make your minimum monthly payment. So essentially when you get a revolving credit or access to revolving credit, and I want you to think differently here, you are literally giving access to, I’m not going to call it a blank check because a blank check would mean there’s no limit, but you are given access to money to deploy how you choose.

So this is why your mindset around this is very, very important. So my whole goal is to shift the way you perceive revolving credit and not necessarily get into the fact where you’re putting yourself in debt, but you’re leveraging this in order to really build wealth like I’m saying, but you need to understand why revolving credit is so powerful. So typically, no payment is due or required if the cash or credit is not used. So this is why revolving credit is so, so pivotal in your particular financial situation in your credit situation, because you literally, while you’re building up a cash reserve, if you have access to revolving credit, this could act as a cash reserve, not in replace of a cash reserve. So I want to make that clear. You’re not going to say, hey, look, I’m not going to build up a pool of cash,

however, access to revolving credit could be that while you’re building up that pool of cash, which is something I’m going to cover in week seven. However, I still want you to get the fact that when you have revolving credit and you’re not using it, no money is, no monthly payment is due, and I just broke this down. But again, this is access to cash when you need it without the monthly payments, when you don’t. So this is again like an emergency fund. So this is like, when I’m putting myself in position, hey look, I’d rather have it and not need it than need it and not have it. Now, the thing about this though, is although you have access to cash when you need it without the monthly payment, when you don’t, this amount, when you do use it does come with an interest rate and it does come with terms.

So that’s why when you do use it, this amount of credit really affects the 30% i.e the amounts that you owe on the credit algorithm the most. Because again, this is like that blank check. So they’re saying, hey, if you have access to this cash, we’re really going to include this in that 35%, I mean in that 30%, excuse me, and, or the 165 points that are available to you. So that’s why, as I was saying previously, we want to make sure that our revolving amounts of credit when we report those balances are at least 1- 7% in usage. However, access to this does not negatively impact you. It empowers you. It puts you in a position of strength, and that also helps you with this score algorithm. So revolving credit is a really, really great thing to have and leverage and apply for and keep on your credit file.

Like I talked about in the previous module about building your credit foundation, and then making sure you don’t close these accounts, you understand this. But again, this is revolving credit at its finest. Now, types of revolving credit accounts. So typically these are going to be unsecured credit cards. So any type of credit card that I get with any type of business or financial institution is going to be an example of the most common type of revolving credit. Now, typically, if you’re on the journey of rebuilding your credit, you’re going to have to do secured cards, which means you’re going to have to secure your card, even though you’re securing with your cash, it’s still going to report as a revolving line of credit. Although you put up the collateral upfront, now I’m going to show you how to circumvent that process.

However, but that is a type of revolving credit. Then you have revolving vendor lines of credit, which means you can go to a specific vendor and they’ll extend a revolving line of credit to do business with them specifically. Typically these are your department store cards. These are the accounts that you can use with that creditor. It still helps you because it’s helping with that 30% usage or that 30% reporting. But again, they’re saying, hey, we’re giving you the ability to come in our store and buy stuff, because we want you to have the ability to pay us back with interest typically. So that’s a really common one, and again, I break down the importance of making sure you pay your balances in full. However, but that’s the type of revolving line of credit. The other one is unsecured lines of credit, which, what this means is you are literally getting a blank check from a financial institution, and it’s not tied to any type of collateral.

Generally speaking, this is if you’re a business owner, you can get lines of credit and or if you have the score available, you can get unsecured lines of credit depend upon that lender. But generally speaking, unsecured lines of credit is just like what it says. It is an unsecured line of credit with the bank or financial institution, and they’re just saying, hey, look, we’re giving this to you unsecured. Now, some very similar to vendor lines of credit, the only difference between revolving vendor lines of credit and unsecured lines of credit is what the unsecured line of credit, assuming you can get approved for one of those, this is a blank check to use wherever you want very similar to a credit card with a higher limit. Now that’s an unsecured revolving line of credit. Now another type of revolving line of credit is a home equity line of credit.

Typically known as HELOC. Now, generally speaking, this is a line of credit that you can take out from or on your home, and it’s access to cash when you need it without the responsibility to, or without the responsibility of having to pay when you don’t. So all of these are types of revolving lines of credit. Now let’s transition. Now that we get revolving lines of credit. This is going to have the biggest impact on that 30% usage. It’s also going to have an impact on the payment history as well, because you want to make your monthly payments on time. But again, you’re not making any monthly payments. If you’re not using that particular line of credit. Now, what is installment credit? Well, installment credit is credit on a debt in which you make regular monthly payments for a specified timeframe until the balance is paid in full. So for example, typically these are backed up or installment loans are backed up with collateral. You’re giving the money upfront to make the purchase of whatever you’re looking to make the purchase of. Then you’re required to start making that monthly payment or making monthly payments immediately, generally, including a predefined interest rate. So examples of this, just so we can be clear, typically these are, this is going to take into account of your debt to income ratio, excuse me, your debt to income ratio.

So paying down or paying off installment credit, even though this is affecting our debt to income ratio, which I’ll get into in the next slide, paying this down or paying this off early, like I said, previously is not going to have an impact on your credit score the same exact way paying down a revolving line of credit would assuming that revolving on a credit is reporting a balance on your credit file. So when you get this installment line of credit, when you get this installment loan, essentially, just because you pay it off early, isn’t going to do anything. Quite frankly, my recommendation is you just kind of just keep paying it. So that way you can build up that history. So this helps with the 35% of your score and or that payment history. So both of them revolving lines and installment credit help out with the 35% or making sure you maintain 192.5 points available, or the payment history section of your score.

However, just because you pay off an installment loan early, which at this point, you now know you should not do or wouldn’t do because of you want to increase the amount of history that you have in your credit file because we’re playing a game here.

However, I’d rather you just pay off a balance on a revolving line of credit that’s reporting than an installment credit, because it’s going to have an impact on your score. So that’s installment credit. So examples of installment credit, you may have already kind of gotten to this, auto loans, home loans, student loans, personal loans, home equity loans.

Now, there’s a distinct difference I want to spend some time here between a home equity loan i.e a second mortgage and the line of credit. Here’s the difference: with the home equity loan, you’re literally taking out a second mortgage and you’re going to have the rules and requirements of this that you pay back over time, the same exact way you will pay with a traditional installment loan. Equipment loans, if you happen to be an entrepreneur, construction loans. So again, these are installment loans. Typically it’s backed up by some form of collateral.

Now, and you have to make sure you make your monthly payments with a predefined monthly amount and or with an interest rate. Now, debt income ratio, and how does all of, how does revolving lines of credit, installment credit, how does all of this come into this factor of DTI and why is this important? Okay, well, let me just first off break down debt to income ratio, because at this point you understand how both of those types of accounts work and potentially which I’m going to show you in the rest of this week, where to go to start establishing them with your particular credit file. So your debt to income ratio is all of your monthly debts divided by your gross monthly income. Now, what you want to do is this is the number, and this is why you need to understand this as you’re getting up to the rest of this program, and you’re now transitioning to where you want to start getting ice and or water.

This is the number that lenders are going to use to manage and measure your ability to make monthly payments to repay the money you plan to borrow, or that you’ve already borrowed. So what they’re doing with this is they’re saying, hey, look, based off this ratio, we believe that you can manage this amount of debt or this amount of loan based off what you already have going on. So typically this is to do with your monthly payments that you already have agreed to. So access, and this is a common myth, and I want you to, I want you to understand this, access to unused revolving credit does not impact your DTI. So for instance, there’s a common question that when people say, well, I don’t want to have access to $100,000 worth of credit because I don’t want to be a hundred thousand dollars in debt.

Well, I have access to $439,000 in revolving credit. I’m not $439,000 in debt. I have access to that capital to use, but as long as I’m not using it, then there’s no monthly payment. It’s not impacting, it’s not impacting my DTI. However, revolving account with existing balances do. Now, what does this mean? So this means if I have, again, let’s just say access to $30,000 in revolving lines of credit, and I’m reporting a balance of $15,000, that means that the monthly payment associated with that balance of $15,000 is going to impact my debt to income ratio. So I need to be very, very clear with that. And not only it’s gonna impact my debt to income ratio, you already understand at this point, it’s going to really, really impact the 30% or the 165 points available to me in that particular part of the credit algorithm, which again, is going to be making a negative impact ,on my score, and 9 times out of 10, increase the amount of interest I’ll have to pay. So how do we calculate our debt to income ratio? It’s really simple. Step 1, what you have to do is add up all of your monthly debts and those monthly debt examples are rent or mortgage.

So whether you’re paying rent or mortgage, that’s your living place of residence. You have to take that amount, then you’re going to take out or take up or take into account any auto loan, student loan, personal loans, credit card payments like I was just talking about or revolving lines of credit payments, child support and alimony. So these are things that you absolutely must pay. Remember, these are also those accounts that affect the 30%, which is why we also want to make sure we continue to make our payments on time. However, we understand the importance of making our payments on time, but this is what we want to do. These are the numbers that we’re going to take into account for adding up what’s considered monthly debt. So even if you’re renting, your rent is still considered a monthly debt. And then what we want to do with step two is divide this number by our gross monthly income and or our GMI.

So that is what we want to do. We want to divide that number. So for instance, or for example, let’s just say, when I stop and I look at all of my debts between auto loans, student loans, personal loans, credit card payments, all of that. It ends up being $2,500. Well, I need to take that $2,500 and my gross monthly income is $7,500. The way I come up with that is I divide the $2,500 by the 47,500. And then that gives me a DTI ratio of 33%. So I’m going to provide a debt to income ratio calculator below this video as well in the resources section. However, it’s really simple for you to calculate. You can just use this particular scenario to do it. Now, why is DTI important and why does this matter?

Well, it’s going to determine the following number one, the amount that you can borrow, I’ve already said that, but again, you need to understand based off where you are. Number one, you don’t want to over leverage yourself because again, credit is a tool. Credit is a tool that we can leverage, and that’s our goal is leveraging credit to purchase assets so we can build wealth. We’re not looking to borrow money to go into debt per se, we’re looking to borrow money. So that way we can purchase an asset. Typically that asset for the majority of Americans is purchasing some type of home or real estate. The interest rate available is going to be determined by your debt to income ratio. So unfortunately the higher the DTI, the higher the interest rate is going to be, because think about it, the lenders like, hey, look, man, this guy got a high DTI. We may or may not get our money back. So we’re going to stick with interest.

The loan available that you qualify for. So certain DTI ratios will qualify you for certain loan products and disqualify you for other loan products. More specifically with your installment loan products. So we want to make sure that we understand our DTI ratio going into certain lending and financial transactions upfront. So that way we can make sure that we’re putting ourselves in the best position to get the best loan product available. Then as I’ve already said, your DTI is going to determine not what you think. Because again, I think you’re awesome. I think you’re beautiful. I think you’re an awesome person. However, the banks don’t look at you like that. The banks look at Xs and Os and algorithms.

So, what they’re going to look at is not what you think you can do. They’re going to look at what statistically has been proven and your ability to pay back the money based off their metrics that they have seen time and time again, which is why they even created this ratio. So, typically 43% is a cut off percentage for the majority of mortgage lenders. So if you’re at a place where you’re looking to really position yourself to purchase a home and you do your calculations, then we want to really start looking at creative ways that we can decrease our debt to income ratio and or increase our income, right? So I’m not making this a lesson in decreasing in debt to income ratio or increasing income. What I am doing is helping you understand how this works. So that way, as you continue to progress with this program, you know exactly how this comes into account when it comes to going out and getting money from the banks.

So with that being said, you understand revolving credit. You understand your installment credit, and now you understand debt to income ratio and how it’s calculated. So your action step for this particular module is to calculate your debt to income ratio so you know. This is going to be an important number that you’ll use later on. So make sure you get this knocked out. So you could do it manually breaking down, breaking down the equation I just gave you, and or you can use a calculator just below this video. All right. So get this knocked out and I will see you in the next module.