Credit is something most adults will use at some point in their lives. It comes in different shapes and forms—credit cards, personal loans, and mortgages are some common examples. Some people stick to a single credit type, but credit bureaus want to see a mix. In fact,10% of your score depends on how many types of credit you have.
If you have only one type of credit, that doesn’t mean you can’t have a decent score. However, if your goal is to have the best credit score possible you may want to consider diversifying your accounts. Learn about how having a better credit mix can take your score from good to excellent.
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Why is it important?
When lenders are trying to decide whether you’re a suitable candidate for credit, they consider various factors. FICO, in particular, looks at the following factors to calculate your score.
- Payment history 35%
- Amounts owed 30%
- Length of credit history 15%
- New credit 10%
- Credit mix10%
They use these metrics to predict whether you can pay what you owe back in a timely manner.
Why is credit mix important?
If you only have credit card accounts, how do lenders know you can manage greater responsibility like a mortgage, for instance? Lenders assume if you can manage a mix of credit types consistently, you’re less likely to default.
Keep in mind that lenders could still approve credit application without a robust credit mix. However, having a strong credit mix can strengthen your credit snapshot.
Also, keep in mind credit mix is only a small fraction of your score. As you can see from the above breakdown, making payments on time and keeping your balances low carries more weight than your credit mix.
Types of Credit Accounts
There are two types of credit accounts: revolving and installment. You’ll understand what they are and the differences between the two below.
A revolving credit account allows you to borrow money consistently and pay it back at your pace. It usually comprises a set credit limit, payment due date, and minimum payments. Revolving credit is appealing as it’s more flexible than an installment account. It does, however, require self-control and one must always consider APR—interest rates tend to be higher with revolving credit.
Installment loans are more rigid—you make a fixed number of payments over an agreed amount of time. For example, if you take out a personal loan for $5,000, you’d likely have to make monthly payments for a set number of years. The lifespan of the loan depends on the terms and conditions you agree to.
However, if your credit card has a $5,000 limit, there is no deadline on when you have to pay it back. You only have a monthly minimum payment which usually covers interest rates or APR.
Examples of Credit Mix
If you’re looking to diversify your credit mix, you could do so using a combination of installment accounts and revolving credit accounts. In case you need examples of each, find a list below.
- Credit Cards
- Retail Accounts
- Gas station cards
- HELOC (Home Equity Line of Credit)
- Student loan
- Personal loan
- Business loan
- Auto loans
- Mortgage loans
Tips for Improving Your Credit Mix
Improving your credit mix is straightforward, but you could experience some bumps in the road. Here are a few tips to consider before you proceed.
1. Create a strategy
Think about what your financial goals are and how you intend to raise your credit score. For example, if you have insurmountable debt, opening a new credit account may not be a top priority. Instead, you should probably focus on paying down your debt, getting credit counseling using credit repair services, or consolidating your debt.
On the other hand, if you have a good credit score and a mix of different accounts, opening a new one may not be necessary either.
If you’re new to credit or have a thin file, it may be time to open different lines of credit. Don’t be afraid of opening a new account. As long as you organize your finances and keep your accounts up to date, your score should improve over time. To avoid missed payments, have your payments come out of your bank account automatically.
Another thing to consider is your budget. If you have a limited inflow of cash, taking out a loan could put you in a tight spot. Think about whether you can afford to take on new debt. If not, there’s no harm in waiting until you can.
There are good options for revolving and installment credit if you’re just starting out or rebuilding a bad score. For example, you can use a credit builder loan and might consider a secured credit card.
Avoid opening too many new credit accounts at once
Once you decide you need to improve your credit mix, don’t run and apply for five new credit accounts within the same timeframe. Be calculated, as too many new credit applications within a short window can have a negative impact. Some include:
- Numerous hard inquiries on your credit report
- Getting denied for credit. Lenders may assume you’re facing financial hardships and thus, a risky borrower.
That said, the impact of a hard pull varies from person to person. As mentioned earlier, it’s more important to focus on having a spotless payment history and
3. Don’t worry too much about dips
Another concern some people have about opening a new account is how it will negatively affect their score. Usually, when a potential lender pulls a hard credit inquiry, your score goes down a couple of points. How many points it goes down is relative—your payment history, length of credit history, and the number of inquiries you have could all impact that.
Nonetheless, dips that happen because of inquiries are usually temporary. Although the inquiry stays on your report for two years, FICO only considers inquiries from the past 12 months.
The long-term rewards of building a good credit mix could outweigh the disappointment that comes from a temporary dip. Lenders will know you’re a pro at managing various credit types and your chances of getting approved for future credit should go up.
4. Consider how closed accounts could affect credit mix
Closing an account can negatively impact your credit mix, especially if you have a thin file. If, for instance, you only have two credit cards and a car loan, paying off the loan and closing that account would mean you won’t have as good of a mix and your score could drop a few points. Likewise, if you close old credit card accounts you no longer use, it could cause your score to dip.
Aside from your credit mix, another reason your score could dip is because your available credit decreases and utilization ratio shoots up.
While your credit mix isn’t the most important aspect of your score, improving it can make a difference. Focus on gradually getting new forms of credit if you don’t have them already and see how it improves your score in the long run.
Article last modified on March 18, 2021. Published by Debt.com, LLC