Breaking Down Credit Scores – Proper Mix of Credit
In the 4th video of the YouTube series which discusses how credit scores are broken down, Derick Vogel explains the “mix of credit” component that makes up a portion of your total credit score.
Having a proper mix of credit makes up just 10% of your total credit score, which is worth 55 points, but is still important when trying to achieve an 800+ score. As mentioned in previous videos, when looking at individuals with scores above 800, it’s important to look at every aspect of your credit score, even if it doesn’t seem like it would make much of an impact. Having the proper mix of credit, for instance, is one of those items you don’t want to ignore simply because it has a smaller impact than other areas.
What Makes a Proper Mix of Credit
Now, when it comes to having a proper mix of credit, which looks at different types of credit, you don’t just want to go out and get loans and credit cards just for the sake of mixing it up. A lot of this will happen naturally over time. Having a proper mix of credit would include having a car loan, a mortgage, credit cards, and charge cards, for instance. Keeping these different types of accounts open will help maintain a proper mix of credit which will help to increase your credit score.
Credit cards, for example, are one of the easiest ways to maintain a good mix. If you can keep 2 or 3 credit cards open at all times and also open a charge card – a card that must be paid off each statement – in addition to having an installment loan open, such a car loan, you will have a good mix of credit. Now, you don’t have to excessively use any of those cards. Simply keeping small balances on each and paying them down each month is enough to keep them active on your credit report and help provide positive credit history.
Many people have the idea that paying off an installment loan, such as a car loan, quicker will help improve their credit score but it doesn’t. Making extra payments or paying more than the minimum to pay it off sooner won’t help your credit score. While you have the loan open and you’re making payments on time each month, you’re building positive credit history. Once you pay off that loan, that loan stops contributing to your credit history and mix of credit. So, there’s no benefit to paying it off early, when it comes to your credit score.
One thing to be aware of in regard to installment loans is that, when first opened, they may initially hurt your credit score. This is because, with an installment loan, you’re receiving a large amount of credit upfront which you then slowly pay off. This adds a lot of debt to your credit report which will have a negative impact initially. That being said, once you begin making on-time payments you’ll start building positive credit history which evens it out. So, just know that you may see a dip in your credit score when you first take out an installment loan before it begins to climb.
As previously mentioned, credit cards are an important part of a proper mix of credit because they are usually easier to maintain without the large financial burden that an installment loan may bring. Ideally, you’ll want to have at least 2 or 3 credit cards open at times. You should maintain a balance under 10% of the limit on each.
Most importantly, never close a credit card, even if you don’t need it anymore. Once you close a card it stops building credit history and your total credit limit goes down. For instance, if you have a card with a $2,000 limit and you close it, your credit limit overall goes down by $2,000 which hurts your utilization (your balance to limit ratio). So, if you prefer not to use a card, just keep it open and simply use it every few months on small purchases which you can then pay off immediately.
Finally, if you have any questions about maintaining a proper mix of credit or have other questions about your credit score, please give us a call today.