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Your credit scores can feel a lot like grades from high school — and they kind of are.
Creditors use credit scores as a tool to assess your creditworthiness — i.e., whether you’re likely to pay credit issuers back if they give you money.
According to FICO, one of the major credit-scoring modelers, your FICO® credit scores are made up of five factors.
- Payment history: 35%
- Amount of debt owed: 30%
- Age of credit history: 15%
- New lines of credit: 10%
- Credit mix: 10%
Let’s consider that last category, credit mix. The amount and types of credit you have help determine this factor.
So what are the different types of credit? And what implications can each type of credit have on your credit scores? We’ll help you figure it out.
- The different types of credit
- A variety of credit account types is best (but not necessary)
- How to apply this to your credit
The different types of credit
There are three types of credit accounts: revolving, installment and open.
- One of the most common types of credit accounts, revolving credit is a line of credit that you can borrow from freely but that has a cap, known as a credit limit, on how much can be used at any given time. It typically refers to credit cards and home equity lines of credit (HELOCs). And it usually requires monthly payments and interest charges if you carry a balance.
- Installment credit refers to loan for a set amount of money with a fixed, regularly occurring repayment schedule. It includes a whole gamut of loans: student loans, mortgages, auto loans, personal loans, etc. This type of credit is also fairly common.
- Open credit is rarer, and many people won’t ever see it on their credit reports. Open credit refers to accounts that you can borrow from up to a maximum amount (like a credit card) but which must also be paid back in full each month. Open credit is generally associated with charge cards — not to be confused with the credit cards used for revolving credit.
A variety of credit account types is best (but not necessary)
While it’s good to have a mix of different types of credit accounts, your credit mix likely won’t be the most important factor in determining your scores.
“Exactly how different types of credit are factored into credit scores is unknown,” according to financial blogger Lyn Alden of Lyn Alden Investment Strategy.
But there are a few common truths that we do know.
Having a mix of credit account types and paying them off as agreed can help show lenders that you’re responsible. Lenders may view you as less of a credit risk because you’re demonstrating an ability to successfully manage different types of credit and the payment systems associated with them.
This means that if you can open and maintain different kinds of credit — say, an installment loan like an auto loan and a revolving line of credit like a credit card — it may be able to help you build your credit scores.
It’s important to note that you should only apply for additional credit accounts if you plan on using the credit, not just to pad your credit reports. According to FICO, it’s “not a good idea to open credit accounts you don’t intend to use.”
Should I open a new type of credit to help my credit scores?
Not unless you actually need it. It’s generally not worth it if you don’t intend to use the account or it means you’ll end up paying extra interest or fees.
How to apply this to your credit
Maintaining good credit scores or building toward them isn’t just about credit mix; it’s also about managing your other credit-scoring factors, especially credit utilization ratio.
Installment loans are fairly easy to understand and manage. You generally make the same payment once a month, every month, until the loan is paid off. But revolving credit is a different beast — to a certain extent, you get to determine how much you want to borrow and pay off each month as long as you make the minimum payment. And though you have the option to pay only the minimum, it typically means you’ll end up paying interest on the unpaid amount. This allows many people to get into credit card debt traps, where their balance (the amount of money owed to the credit card company) gradually grows over time.
Increasing the amount owed to a credit issuer bumps up a user’s credit utilization ratio, the total amount of credit card debt owed compared to the total amount of available credit at a given time. The credit utilization ratio likely affects credit scores even more than credit mix. This one factor dictates about 30% of your FICO® credit score — way more than your credit mix alone.
That’s why it’s especially important to keep an eye on your revolving credit accounts. By paying off your credit card bills on time each month (another important credit-scoring factor) and keeping your credit card balances low, you can keep your credit utilization down and help your credit scores even more. Plus if you pay your balance on time and in full each month, you likely won’t have to pay any interest.
Keeping your debt levels low (especially credit card debt) and paying off your accounts on time are important steps you can take to help your credit scores.
Having a healthy mix of credit, such as revolving and installment credit, can also help your credit scores. Staying on top of your payments regardless of credit type can help show lenders that you can responsibly handle various types of credit.
But remember, if you don’t absolutely need to open a new type of credit account, it’s probably not worth it — just focus on maintaining good spending and paying habits on whatever existing credit you have. Your scores can still benefit from that.