Why You Should Care About Credit Mix
It’s important to find the right balance in life, and that’s true of your credit, too. To achieve a high credit score, you’ll need to have a good credit mix, which means having several different types of accounts on your credit report. These can include credit cards, auto loans, student loans and mortgages. A diverse mix demonstrates to lenders that you can responsibly manage a range of financial responsibilities. So, as long as you pay your bills on time and control how much you owe, having a variety of accounts will help improve your credit score.
The most commonly used credit scores are issued by the Fair Isaac Corp., or FICO, which bases its formula on five ingredients:
- 35%: Your bill payment history
- 30%: How much you owe on credit cards and loans, as well as your credit utilization rate
- 15%: The length of your credit history
- 10%: The mix of accounts you have, including credit cards, installment loans and home loans
- 10%: Recent credit activity, including opening new accounts
VantageScore, another credit scoring company and FICO’s main competitor, may place a slightly greater emphasis on credit mix.
Why you should care about credit mix
By diversifying your mix of credit, you can help boost your credit score. Your portfolio of accounts plays a small but critical role in showing lenders how you handle debt. If your credit report doesn’t show a lot of activity or you’re just establishing credit, a variety of credit can help build a foundation.
How to diversify your credit mix
If you’re looking to expand your credit mix, start by analyzing your existing loans and credit cards. Ideally, you should have both installment credit and revolving credit. When FICO calculates your score, its formula considers a wide variety of loans, including credit cards, retail accounts, installment loans, finance company accounts and mortgages. Here’s what you need to know about the different types of credit:
Installment credit. These are are loans with a firm pay-off date and scheduled payments, such as a mortgage, student loans, auto loans and personal loans.
Revolving credit. These are accounts that are ongoing and don’t have a fixed end date. Borrowers are required to pay a minimum monthly amount and carry the rest of the debt, also known as revolving, but they can also elect to pay more. Credit cards, retail credit cards and home equity lines of credit (HELOC) are all types of revolving credit.
Open lines of credit. Open lines of credit are accounts with an unspecified amount owed that are expected to be paid monthly. These are often utilities, such as your cable, electric and cellphone service.
Potential issues with your credit mix diversification strategy
It helps your credit score to have more than one type of loan, including more than one credit card. But, in your zeal to establish credit, it is possible to lower your credit score with too much activity. The idea is to demonstrate an ability to balance debt responsibly, not to take on so much that you struggle. Wells Fargo, for instance, suggested an ideal credit mix would include a mortgage, a car loan, a home equity loan and one or two credit cards. Too much activity could actually have a negative impact on your score. As you work to improve your credit mix, be sure to avoid the following pitfalls:
Too many hard inquiries. If you apply for several types of loans within a short period of time, these hard inquiries could have a small impact on your credit score. Hard inquiries occur when a lender, such as a mortgage, auto loan or credit card company, reviews your credit report as part of their approval process. Too many hard inquiries can be a red flag for lenders because it indicates a potential uptick in debt or that you’re possibly overspending. In contrast, soft inquiries, which occur when a creditor checks your credit report as part of a preapproval process or as part of a background check by an employer or landlord, do not impact your credit score. The soft inquiry is not directly tied to your debt or loans, so it does not impact your credit score.
Opening a lot of lines of credit too quickly. Just because you qualify for a number of loans or credit cards doesn’t mean you should take advantage of all of the offers. Applying for several new accounts at the same time may have a negative impact on your FICO Score. While FICO considers credit mix as part of your overall score, the company recommended consumers open fewer accounts and manage them responsibly.
A better strategy to expand your credit mix
Rather than rushing out and applying for a bunch of new loans or credit cards, take a breath and proceed slowly. Start by doing your homework. If you want a new credit card or two, consider the perks or programs that come with each and what works best for you, then apply for the one that best meets your needs. You might use the same strategy when applying for auto loans, mortgages or personal loans. And, of course, consider whether you can handle more debt or additional accounts.
The bottom line
While credit mix doesn’t carry as much weight as your payment history or your debt load, the 10% that it represents might take your score from good to great. However, before you sign on for new loans or cards, review your credit report and make sure you can handle more accounts. With responsible financial habits, a diversified credit mix could help you accomplish more of your financial goals and boost your score.