Types of Credit and Their Influence on Your Score
July 11, 2014 July 11, 2014
Your credit score is complex. Here at Credit Karma. we’re committed to helping you break it down. There’s always more to learn.
If you’re looking to get a grip on the factors that influence your credit score, Credit Karma is a great place to start. The six elements explored there (credit card utilization. payment history. derogatory marks. age of credit history. total accounts and credit inquiries ) are all vital to your credit health, and how you rank in each of these categories will go a long way to determining your score.
Still, there are other factors to keep in mind when you’re thinking about your credit health, like the types of accounts you have on your credit report. A healthy mix of accounts is generally thought to be preferable to a report dominated by just one type. Read on to dig into the different types of credit accounts and how you can strategize for the best score.
Types of Accounts
There are three general categories of credit accounts: revolving, installment and open.
A revolving credit line is one that involves different payments each month, depending on how much you utilize that particular line of credit. The amount you pay is subject to a monthly minimum payment and you have the option to push the rest of what you owe to the next month, subjecting yourself to additional interest in exchange for extra time.
The most common examples of revolving accounts are credit cards. Home equity lines of credit (HELOCs), which allow you to borrow against the value of your home, also fall under this category.
As opposed to a revolving credit line, an installment account has a fixed payment due each month. The total amount borrowed with an installment account is to be paid back over a set period of time and a set amount of interest is charged over the duration of the loan.
Installment accounts include any loans on your credit report. Mortgages, auto loans, student loans, business loans and home equity loans are all paid back as part of an installment plan and fall under this category.
The final type of credit is the open account. Open accounts each have a balance that is to be paid in full every month. There is no pushing your debt to the next month, no installment payments over long periods of time and, generally, no interest charged.
Examples of open accounts include company charge cards, cell phone accounts and other home utilities. Since the balance on these accounts is typically paid in full each month and no interest is charged, these accounts will not always be present on your credit reports. Companies that choose to report open accounts generally only report them when there is a delinquent payment, but creditors may choose to report them either way.
Finding the Right Mix
This is where it gets tricky. There is no magic formula for the perfect ratio
of one type of account to another, and since open accounts are not always reported to the credit bureaus, you can't rely on those being particularly useful for your credit mix. There is, though, a general consensus that a variety of revolving and installment accounts is a positive indication of responsibility and credit experience, provided you stay up-to-date on your payments.
If you have a credit profile that is dominated by credit cards and only credit cards, think about whether you're in a position to add a little variation to your finances. It's generally beneficial to have at least one or two installment loans in your credit profile. A mortgage is particularly helpful, but loans in general indicate that you have the maturity and responsibility to make steady payments over a long period of time. Having installment accounts on your credit report could also enhance your lenders' and the credit bureaus' perception of your financial experience.
Reviewing your credit report details is a great way to get a handle on your credit health, but having a variety of accounts is also worth your consideration. Look over your full list of reported accounts to get a sense of what types of accounts you have open now, and then decide if you can strike a better balance. It's important to only open new accounts when you can afford them (a derogatory mark will likely do more damage than a lack of variety, after all). Still, if your report is stuffed full of credit cards and you need a new source of credit, choosing a loan instead of a credit card might be a good move next time you're in need of a new line of credit.
Account mix isn't the end-all be-all of your credit score, but it is one factor to keep in mind next time you take stock of your credit health.
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About the Author: Mike Goldstein is a Content Writer at Credit Karma. Since joining the team in June 2013, he's been delivering the financial know-how on the daily. When away from work, you can find Mike watching hockey, Twittering for hours and frequenting trivia nights.