In my post on Revolving Credit, we looked at what revolving credit is and how it impacts credit scores.
Our next component is the debt we pay that does not revolve and does not allow our credit to be available for new borrowing like we have on our credit cards. This is called Installment Debt. Installment debt is the debt where we have borrowed and have to pay a fixed amount each month to stay in good standing with that loan.
Types of Installment Debt
Generally, there are 3 types of installment debt
1) Home Mortgage (by far the largest and most common)
2) Car loans and car leases
3) Recreational merchandise (Boats, RVs, jet skis and the like)
Notice that all of these loans are done with fixed payment terms that are paid over a period of time. 15 or 30 years are the typical home mortgage term and 3, 5 or 7 years for car loans. Like with our mortgages, we are paying a portion for principal and a portion for interest each month. Car leases don't have a principal and interest component but the payment is fixed each month.
Is Installment Debt Good or Bad?
Unlike revolving debt, where using more of it negatively affects your score, that is not necessarily true with installment debt. Every credit profile has its biggest debts in installment debts, namely the home mortgage. So in this case, we want our borrowers to have installment debt cause homeowners are preferred to renters. Too much installment debt may be good or may be bad. Someone who owns multiple properties with lots of mortgages can either be a positive if they have net worth and we believe it means that they can afford our loan or it can be a bad thing if we think they may be overleveraged personally.
Which type of debt are Peer to Peer loans?
So based on what we know about installment debt and revolving debt, which type are our peer to peer loans? Even if they are being used to consolidate credit cards and other revolving debt, the loans we are investing in on the lending platforms most closely adhere to installment debt characteristics. Why? Because the payment is fixed, the loan is fully amortizing over the term and has a portion going to principal and interest each month.
While we don't necessarily want someone who has a zillion loans on the books of installment debt on their credit profile but by no means is all installment debt bad debt.