Different types of credit are known as a credit mix. It may include credit cards, home loans, personal loans, automobile loans, etc. Balancing the risk versus rewards will help you in having a good credit score.
First thing first. Having a good mix of different types of credit accounts adds to the basic hygiene factor of your credit report. However, it is not the most important aspect that shapes your credit score. Lenders and financial institutions do check your credit report when you apply for a loan or a credit card. Assessing your credit report helps them understand your creditworthiness. The better your credit score is, the higher the chances of your application being accepted.
Let us delve a bit deeper into the different types of credit accounts and how they may likely impact your credit score.
What are the Different Types of Credit Accounts?
Before you start analysing your credit report based on the mix of credit accounts you have, you must know what they are and how do they work.
Majorly, there are three (3) different types of credit accounts, and they are:
1. Revolving Credit
By definition, revolving credit is a line of credit where a borrower is assigned a set credit limit with which they can use the credit. The repayment has to be done over a period of time. A revolving credit can be a secured loan or an unsecured loan. In a secured form of revolving credit, a borrower has to offer a mortgage or a lien to take out the loan. While an unsecured form of revolving credit doesn’t need any security in form of collateral.
For example, a home equity line of credit is a secured form of revolving credit and a credit card is an unsecured form of revolving credit.
With this type of credit account (revolving), the credit limit is fixed and it doesn’t increase. The borrower may have to pay the debt along with the interest charges, if any, in the form of monthly payments.
2. Instalment Credit
This type of credit account is mostly used to buy big ticket items. Instalment credit is generally used for paying for specific products. The price of the product is then split into equal instalments to be paid by the borrower.
Let us understand it through an example. Suppose, you have added a few items to your cart on an online shopping website. The entire cart amount will be spread over a pre-defined period that you have to repay.
3. Open Credit
Open credit is a type of credit account that is least preferred by the consumers. Why? Because it has a fixed limit on how much a borrower can spend, however, the borrower also has to repay the entire amount spent in a single shot.
How do Different Types of Credit Accounts Impact your Score?
Credit diversity is one of the most common factors that is taken into consideration while calculating your credit score. If you have different types of credit accounts, such as personal loans, home loans, credit cards, and a car loan, lenders think that you can successfully manage different types of debt.
Maintaining a variety of credit accounts will help you improve your credit score. That does mean you should open different credit accounts you don't need. Because not having a mix of different types of credit accounts will not lower your credit score.
Depending on the credit scoring methodology, your credit mix may be one of the lesser factors in credit score calculations. Your payment history on your accounts; the duration of your credit history; your debt to credit ratio, and the amount you owe on your credit accounts will be used to compute your credit scores.
However, if you have a mix of different types of credit accounts, ensure that you repay the debt on time and in full. If you fail to manage your credit accounts and default on the repayments, it will impact your credit score. Eat as per your appetite. Do not go over the board just to keep up your credit score. It may backfire if you do not have a proper financial planning to achieve the goal that you’ve set. If you decide to add different types of credit accounts to your portfolio, create a budget and work around it. Assess your current financial standing and then decide on it.
You need to figure out the reason your credit score is struggling, if you wish to improve it. Remember, your credit score will not increase overnight, you will need to put in some good amount of effort by developing financially healthy and responsible habits.