How your FICO score is calculated: Credit mix
You'll gain points by paying off different types of loans
This is the fifth and final installment of a series examining what goes in to creating your FICO credit score -- the three-digit number that helps determine how much you can borrow and on what terms. Each part of the series takes an in-depth look at one of the five basic components of the credit scoring model. Today: types of credit used.
Want good credit? Responsible use of a single loan can get you there.
But if you want a top FICO credit score -- the kind that gets you the best rates, the highest limits and the sweetest deals -- you're going to have to mix it up a bit.
That's because FICO says having a variety of loans is necessary for earning a perfect credit score. If you don't have several different types of loans, it won't kill your score. After all, the "types of credit" component is the least important of the five factors in FICO's formula. But if you're striving for scoring perfection, the only way is to responsibly handle a good credit mix.
Banks take a similar view. "Lenders want to see that you've handled different types of loans well, especially the type of loan that they would be extending," says Jennifer Wallis, vice president of the Consumer Credit Counseling Service of Central Oklahoma.
Getting high marks from FICO can save consumers both money and time: Borrowers with high FICO scores may enjoy lower interest rates and a higher likelihood of loan approvals. So self-education is important. By understanding FICO's scoring model, borrowers can take the necessary steps to ensure they score well.
To calculate its score, which ranges from 300 for borrowers with bad credit to 850 for borrowers with pristine credit, FICO considers five different factors. Those include:
1. Your payment history
2. How much total debt you have
3. How long you've had credit
4. How much new credit you have
5. What types of credit you have used
Coming in at the bottom of that list, your credit mix makes up about 10 percent of a consumer's FICO score. It carries the same weight as the new credit category, which looks at how much credit you've received or applied for in recent months. But, in reality, the two categories aren't quite equal.
"For the most part, it can be considered the least important of the five main components," says Barry Paperno, consumer operations manager at myFICO.com.
Based on FICO's research, having various types of debt isn't the strongest predictor of whether a consumer will repay loans, but it is helpful. "FICO's research has found that, all things being equal, consumers with a 'mix' of credit types on their credit reports tend to be less risky than those who have experience with only one type of credit," FICO's Paperno said in an email.
According to credit counselors, potential lenders feel the same way.
"It's important to have a good mix between installment and revolving to prove to a creditor or lender who's looking at the report that you can handle different types of credit," says Wallis. Installment loans include mortgages, auto loans and student loans, while revolving loans include bank and retail credit cards.
What credit types does FICO consider?
As for FICO, its scoring formula looks at both the number and variety of accounts listed on a borrower's credit report. "The number of each type of account is not as important for a person's score as simply having experience with both types of accounts, either currently or within the recent past," Paperno says.
Various types of loans appear on a credit report and can be factored into a FICO score. Unpaid accounts that have gone into collections can also appear on a report and negatively impact your score.
Although credit reports typically include similar types of information, the data collected by each credit bureau can vary somewhat. The credit reports from credit bureau
Experian, for example, may include the following:
- Installment loans, including auto loans, student loans and furniture purchases
- Mortgage loans
- Bank credit cards
- Retail credit cards
- Gas station credit cards
- Unpaid loans taken on by collection agencies or debt buyers
- Rental data
FICO considers all those types of accounts, with the exception of the rental data, which Experian began adding to its reports in early 2011. As of now, FICO says it's still too early to know whether rental information can be used to predict loan repayments, so it has chosen not to include it in score calculations.
Taking on various credit types
Consumers' on-time rental payments may not boost their FICO scores, but the appearance of those other loan types on their credit reports should be beneficial -- assuming they have positive payment history, of course. "Generally, it's a good idea to have had some experience with revolving and installment credit accounts," FICO's Paperno says.
Does that mean you should go down the list and apply for mortgages, student loans and various credit cards in order to build up your FICO score? Not exactly, experts say. "When you are making the decision to broaden the types of credit you have, you should be reserved and selective in the types of credit cards you get," says Consumer Credit Counseling Service's Wallis.
"A credit card -- or any kind of loan -- should be a deliberate decision," she says.
Other credit counselors agree. "There is good borrowing and bad borrowing; we emphasize this with our clients," Tia Jiron, credit counseling servicing director with Pioneer Credit Counseling in Rapid City, S.D., said in an email.
And not all credit cards are created equal. "A major bank credit card is going to be better for you than a department store credit card. Not only is the interest rate going to be lower, but you can use it anywhere," Wallis says. Those bank cards are typically harder to get than retail cards, she says, demonstrating to lenders that you have a better credit history. That's why consumers need to think carefully before applying -- especially for retail cards. "Don't go from store to store getting credit cards because you can get 10 percent off today," Wallis says.
But what's the harm in applying for many loan types? Along with the initial FICO score drop that can happen when the lender checks your credit (what's known as a "hard inquiry"), there is the danger that you won't be able to handle that credit responsibly. That could lead to more problems down the road.
Credit counselors say that's especially true for credit cards. Unlike installment loans that are capped at a set amount, "revolving accounts are a little more of a wild card because you could go out and charge that up if you wanted to," says Wallis. Others agree. "Credit cards carry a high risk for many individuals. This can allow them to overextend very quickly," Jiron says. Being overextended can hurt your score: FICO data show that maxing out a credit card can lower your credit score by as much as 45 points. So if you're tempted by the thought of going on a charging spree with your new plastic, adding another card to your wallet may not be wise.
Focus on the fundamentals
Rather than applying for loans in an effort to boost your score, for most borrowers, it makes sense to focus on the FICO fundamentals instead.
Since FICO says a good score is more dependent on always paying bills on time, keeping credit card balances low and opening new loan accounts only when necessary, there is little reason for most borrowers to actively seek out a mix of credit.
For consumers who are considering their credit mix, "it's best to consider this category as more of a 'good to know' than a 'got to know' for a good FICO score," Paperno says.
See related: How your FICO score is determined: Payment history, How your FICO credit score is calculated: How much you owe, How your FICO credit score is calculated: Length of credit history, How your FICO credit score is calculated: New credit, Nonprofits innovate to help low-income people establish credit, Rent-to-own home payments unlikely to aid credit score, FICO reveals how common credit mistakes affect scores
Published: September 8, 2011