You are just starting to build your credit file and the question is what types of credit will help to build the highest score in the least time possible? Understanding what credit mix is helpful to your score is important to the long game in building a strong credit file.
There are three specific types of credit that are on your credit report when you are building your credit file. Revolving, Installment and Open. In short, the answer is, it has less effect on your score than you may think. Only 10%. The scoring system wants to see you manage different types of credit responsibly. It is important to have a variety of revolving and installment credit accounts but it is not the most important factor.
Having a good mix of credit it not just about your credit score. Many lenders require a certain amount of credit accounts to qualify as well.
What Really Drives Your Credit Score
Payment history and your balances are always going to be the main drivers of your credit score. There are myths that certain credit cards and loan types from second-chance lending companies somehow reflect negatively on your score.
If you are always paying your payments on time and keeping your balances lower than 30% of your credit limit on revolving credit cards, then in time you will drive your credit score higher and higher.
Here are the top 5 credit factors that matter in determining your FICO score.
- Payment history: 35%
- Amount of debt owed: 30%
- Age of credit history: 15%
- New lines of credit: 10%
- Credit mix: 10%
For the purposes of this article, we will show you how Credit Mix should be utilized to raise your credit score. Having diversity on your credit file does help to drive your score higher.
Although it is not the first thing you should be worrying about it, you will want to utilize this information to make sure you are driving your score as high as possible. You will want to address every aspect of the drivers.
What Types Of Credit Are There
- Revolving – Most revolving accounts are credit cards, home equity lines of credit and personal credit lines. They are called revolving because you have a credit line or limit. When you pay them down your available credit is replenished and you can borrow against that credit line over and over. Even when you pay it off it can remain open to use at a later date.
- Installment – Installment loans are paid back with set monthly payments over a predetermined amount of time. Once the loan is paid back then the account is closed out. Auto loans. mortgages and personal loans are considered installment loans.
- Open – Open credit is usually a charge card that must be paid off every month. The closest one to an open account that you may be familiar with is the American Express green, gold and platinum card cards that require you to pay them off every month. You are not charged interest because there is no expectation of the balance remaining more than 30 days. Open credit is used more with businesses rather than consumers.
What Mix Of Credit Types Should I Strive For?
Qualifying for credit cards, auto loans and mortgages may not just be about your credit score. In addition to having credit score requirements, many lenders also look at the types of credit you have, the length of history on the account, and other factors that determine whether or not they will lend you money.
These are called lending guidelines.
As a general rule of thumb, when I was helping someone prepare for the mortgage process, I always recommended that they have a minimum of three to five trade lines. Some lenders require a certain amount of trade lines to qualify for their loans in the guidelines.
As an example, a good mix of credit looks like this if you are striving for a good credit score.
- 1st Credit Card
- 2nd Credit Card
- 3rd Credit Card
- Personal Loan
- Auto Loan
What Does This Mean For Your Credit
Paying one loan off with a good payment history will certainly improve your score. If you want the best credit score you can achieve that by having a good mix of credit accounts with several different types of loans to get you there.
FICO says that not having diversity in your credit file will not obliterate your score since it is the least of the factors in the FICO scoring models. But if you want to get the highest score possible it is good that you are learning about this and taking it seriously.
Lenders also want to see that you can manage different types of credit. They often require that you have certain types of loans in their guidelines.
Obtaining a personal installment loan is fairly easy to do once your score is in an acceptable range. I always recommend that you obtain the loan and put the money in a savings account and have the payments taken directly from there to help build your credit quickly. You will have to make sure as you get to the end of the loan that you add additional funds to cover what was taken over time in interest.
If your score is not in an acceptable range, there are secured installment loans that you can look into to get the diversity you are looking for and get your score as high as possible.
What Will A Higher Credit Score Do For You?
The higher your credit score the better your rates and terms will be when you try to borrow money. Having a high credit score can mean you will save thousands of dollars in interest charges over time. It also may mean better terms for your loan or even getting approved for the loan at all.
Here is an example from when I worked in retail banking:
Bank A – We offered a $25k personal loan to our customers with a repayment term of 10 years. It offered easy qualifying (no income verification) which meant fast approval and funding for the borrower. The rates were from 8-10%. The loan required you to have a minimum of 720 credit scores.
Bank B – They offered a personal loan with a minimum credit score of 680. However, the borrower has to provide all income documentation. The highest amount you could borrow was $10k over 5 years. It typically took a week to close the loan and get the funds to the borrower. The interest rates were 12-14% and there was an origination fee of $100.00 or 1% of the loan amount and a closing fee of $25.00.
The Result Of A Lower Credit Score
A lower credit score can make all the difference in what rates, terms and conditions you are given when applying for the loan. Also, let’s not forget the convenience factor of being able to close your loan in 24 hours and not having to provide income documentation.
You can see the cost difference between the two loans is $125 right off the bat. The interest savings, assuming both loans are at their best rate, with the same loan term of 5 years, was about $600. That is a total of $725.00 over 5 years. Imagine if this was a mortgage or an automobile. You could save thousands over a 30-year term.
Having a higher credit score not only saves you money but it offers better opportunities as well.
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