- Posted by: Administrator
- Category: Finance
Most of us know how to check our credit scores, and we know some of the factors that go into it, but it can get confusing. With so much competing information, a lot of us are stuck operating completely on the basis of rumor.
One of the more common rumors that I’ve heard, of course, is that you can improve that score just by changing your credit mix. But is it true? And what exactly is a credit mix?
The answer to the first question is… it’s kind of true, but there’s a catch. And that’s all because of the answer to the second question.
What Is a Credit Mix?
Your credit mix refers to the diversity of all the different kinds of credit products you’ve had in your lifetime. It’s part of your credit history, but a good way of thinking about it is that instead of measuring your credit by how deep your experience is, your credit mix measures how broad it is.
Someone with a less diverse credit mix, for example, could have many different credit cards, but no automobile loans, no mortgage, and no student loans.
It may seem like broadening your credit mix is an easy way to change your credit score, but the catch is that it’s actually a very small part — about 10% — of how your score is calculated.
To understand exactly how your credit mix affects your credit score, though, it’s important to understand what a credit score means in the first place.
Credit Mix: Just One Part of Your Credit Score
You might think of your credit score as a measure of how well you’ve managed your credit in the past, but that’s not the whole story.
A credit score, more accurately, is a simple and standardized way for lenders to predict your future behavior. If you have a high credit score, it means not only that you’ve managed your credit well, but that you are likely to continue to manage your credit well.
Your credit score is based on five factors, including your payment history, your total debt, how long you’ve had credit, how much of your credit is new, and your credit mix.
For example, a high score means that if you take on an auto loan or open a new credit card, you’re likely to pay on time and avoid defaulting on your loan.
Different Types of Credit
Three kinds of credit are available: installment credit, revolving credit and open credit.
Installment Credit Accounts
These are meant to be used once for a specific purchase and, when paid off in full, are automatically closed. The most common installment credit account is a student loan, which is often the first entry in your credit history.
These accounts also include automobile loans and mortgages, which tend to be high-limit and low-interest rate loans, because they’re borrowed against property that can be recovered in the case of a default.
Revolving Credit Accounts
With these accounts, if you pay off what you owe, you can borrow up to your limit again. Most of us have at least one of these accounts in the form of credit cards, which typically carry a high interest rate.
Another example is a home equity line of credit, which differs from a mortgage in that there’s no fixed amount you must pay each month.
Open Credit Accounts
These must be paid off in full every month.
Your utility bill and cellular bill, for example, are most likely open credit accounts, and if you miss a payment or are late in your payments, your credit score will suffer.
What Is a Good Credit Mix?
Here’s where it all comes together.
Lenders aren’t just looking for consumers who are responsible with their student loans or who can pay back a single credit card on time, and that makes sense.
Just because you can pay off one card every month doesn’t mean that if you opened another, you’d be able to pay them both off every month.
Instead, lenders want to know that you can handle a number of different credit products at once because that does indicate that you can responsibly take on more credit.
Giving a new credit account to someone who regularly pays back their credit with a diverse credit mix — like a credit card (revolving), a student loan (installment), an automobile loan (installment) and a cell phone account (open) — is a good bet for the lender, because that person is unlikely to default.
All that to say: yes, a good credit mix can improve your credit score.
Are Closed Accounts Bad for Your Credit Mix?
No! A closed installment credit account stays on your file and contributes positively to your credit score because successfully closing an account means you are likely to successfully close accounts in the future.
With that in mind, though, if you have completely paid off a revolving account like a credit card or a home equity line of credit, it’s better not to close it unless there are monthly fees associated with the product.
An unused revolving credit account contributes positively to your score and offers you a safety net in the case of unexpected circumstances like home repairs, a new baby or a Tunguska-style meteor strike.
The Bottom Line: Stick to the Credit You Need
Be responsible with your credit! The most important rule of thumb is only to get a credit product if you need it.
In the case of installment accounts, that means only getting an automobile loan if you need it to buy a new car, or only getting a mortgage if you need to buy a new house. Most of us aren’t running around with multiple cars and multiple houses, so this should be self-explanatory. (If you do have multiple cars and houses, you might be on the wrong site.)
When it comes to revolving accounts though, it depends on your definition of “need.” Do you need a second credit card? Maybe not. Do you need the first one? It could be a good idea because if you’re responsible with it, it can help you improve your credit mix and credit history.
Ultimately, those are questions only you can answer, but the best recommendation is always to let your credit build up organically.
SOURCE: THE PENNY HOARDER