Paying your bills on time and only using a portion of your available credit may help your credit score. However, these good habits are not the only factors shaping your credit score. Your credit mix also affects your score. The credit mix makes up 10% of your FICO score.1
Want to avoid a credit mix-up by having the appropriate mix? Then, here's what you need to know.
What Are the Different Types of Credit?
The two main types of credit are revolving and installment. Revolving credit allows you to spend up to the credit limit, pay it off and spend it again. It is revolving because you use, pay and reuse the credit as often as needed while the line is open.
In contrast, you borrow a set amount of money with an installment loan. Then, you make monthly payments, called installments until you fully repay the loan.
What Is the Credit Mix?
A credit mix is having both installment loans and revolving lines of credit. A mixture may show that you are responsible for both types of credit. For example, by sticking to the terms of an installment agreement, you demonstrate that you make regular monthly payments over a long time.
In contrast, revolving lines of credit indicate that you understand how to use open lines responsibly. When someone reviews your credit report, they see whether or not you max out open lines of credit. They also determine if you make your monthly payments on time and how much credit you carry forward every month.
How Does the Credit Mix Affect the Credit Score?
Your credit score provides a snapshot of your creditworthiness and your responsibility levels. A prospective lender looks at your score to decide whether or not you pre-qualify for a loan and then, for more details, looks through your current credit report.
Think of a credit score as a shortcut for lenders. In most cases, when you take out a loan, the underwriters take a fairly detailed look at your credit report, but they almost always look at the credit score first. If it does not qualify, a lender may deny your application at that point without even looking at your credit report.
How to Improve Your Credit Mix
Now that you understand the importance of a good credit mix, you may wonder how to strike the appropriate balance. First, pull a copy of your credit report and look at how many different types of credit you have. Do you have a lot of revolving debt but no installment loans? Or are you struggling with the opposite issue? In either case, you need to consider taking out an additional line of credit.
For instance, get a credit card if you have a car loan but no revolving lines. If you struggle to get approved for a mainstream credit card, try a card from a retail store or a gas station. They have higher interest rates but are easier to obtain.
If you have the opposite problem and have revolving credit but no installment loans, take out a car loan or a personal installment loan. Even if you could afford to pay for a car in cash or already own your vehicle outright, taking out a loan improves your credit mix and may help build your credit score.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
All information is believed to be from reliable sources; however LPL Financial makes no representation as to its completeness or accuracy.
This article was prepared by WriterAccess.
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1 What's in my FICO® Scores?