Rules of the road for improving your credit mix
Done right, a diverse mix of loan types can nudge up your score
Looking to edge up your credit score to get the most
attractive rate on a mortgage in the next year or so?
While handling credit cards responsibly is the best way to
boost a credit score, if you need to break through a barrier, you can look to
your credit mix. Having greater diversity in the types of credit you use can nudge
your score up -- as long as you make your payments on time.
The biggest factors in calculating your credit score are payment history (35 percent) and the
amount you owe (30 percent), according to FICO, the San Jose, Calif.-based
agency that calculates and issues FICO credit scores. Length of credit history
(15 percent), new credit (10 percent) and credit mix (10 percent) make up the
rest of the pie.
While credit mix is a small category, it can make a
difference if you are struggling to shift a FICO score up a notch -- from, say,
720 to 740. "We're talking about 10 to 20 points, not 100," says Ethan
Dornhelm, principal scientist at FICO.
Having a variety of successfully managed credit accounts, ranging
from revolving credit cards to installment loans (such as personal loans, auto
loans and mortgages), shows responsibility in handling a wide variety of credit
types, Dornhelm says. "If we look at risk patterns, we find that people who
show a healthy balance of usage of all types are a lower risk," he says.
No pain, no gain
Before you go hunting for new credit, be warned: Taking on
different types of credit won't automatically boost your score. In fact, your score
may dip temporarily, Dornhelm says, when the lender performs a hard pull on
your credit to determine your ability to repay. Hard pulls are just temporary
dings, however, as long as you proceed slowly and carefully when applying for
new credit. Too many new accounts may be interpreted by a lender as a sign you
are in financial trouble.
But making payments on time will help your score recover. For
example, Dornhelm says taking out a $5,000 car loan has the immediate effect of
lowering a score because it's new credit. After making five steady payments, though,
your score should rebound to its former level and then some.
Just make sure you can afford those payments. If you take on
debt you can't afford, you'll end up doing more harm than good. Paying on time is key. "As long as you demonstrate responsible use,
you'll benefit," says FICO's Dornhelm.
With that in mind, here are some good -- and not so good -- ways
of adding variety to your credit mix with installment loans. A green light
means go ahead, as long as you've weighed the pros and cons. Yellow means
take care -- there could be trouble ahead. Steer clear of the red lights.
Car loan: green light
Even if you can afford to pay for a car with cash, you may want to consider
paying it out over time. If your credit is good, you
may qualify for a very low-interest loan that could help your credit mix and
eventually boost your credit score even higher.
You can get car loans from several different sources. Most
dealers are affiliated with finance companies that offer loans. You can also
get a loan through your bank or credit union. The better your credit score, the
lower the interest rate you'll be offered.
If your score is less than stellar, consider using a credit
union. Interest rates at federal credit unions are limited by law to 18 percent,
and may be more reasonable than rates at buy-and-drive car lots or finance
companies, says Rex Johnson, owner and founder of Lending Solutions Consulting
Inc., a credit-union consulting firm in Elgin, Ill.
In addition, nonprofit credit unions want to help people
build credit scores and are more forgiving of less-than-perfect credit,
How long should the loan be for? Let your budget be your
Johnson says that, because credit history counts for 35
percent of your FICO score, a longer loan paid off faithfully will do more to boost your
credit score than a shorter loan.
But you'll end up paying more interest with a longer loan, and it's not worth stretching
out your loan terms just to improve your score, Johnson warns.
loan: green light
Personal loans are generally made to individuals without any
collateral needed. People use personal loans for consolidating credit card balances,
paying tax bills, financing weddings or any number of other expenses.
One of most attractive things about personal loans is that they may have a lower APR than a credit card. San Francisco-based Wells Fargo, for
instance, offers personal loans from $3,000 to $100,000, starting at around 7
percent APR. That compares to the average credit card APR of 14.96 percent.
Peer-to-peer loans arranged by companies such as Lending Club and Prosper are an
increasingly popular route to personal loans.
Those firms report your account activity to the credit bureaus, meaning they
should help build your credit if you pay on time. You generally need a very
good credit score to qualify, but the application process can be easier than
going through a bank.
Student loans: green light
FICO also considers student loans when
looking at your credit mix. As installment loans, student loans carry the same
weight as, say, a car loan, Johnson says.
The key to having
student loans build your credit score is to stay on top of the payments. Ideally,
that means making the required payment every month. It can also mean keeping in
touch with lenders if you can't pay on time. Heidi Berardi, director of education and community outreach at
the nonprofit credit counseling organization Family Credit Management in Chicago, advises contacting the
National Consumer Law Center's Student
Loan Borrower Assistance Project if you're having trouble with payments. They can help you find out about consolidating your student loans. "If you are communicating,
you're current," she says. "That's very big."
Red lights: How NOT to improve your credit mix
Thinking of using any of the following to
improve your credit mix? Forget it. They'll cost a bundle and won't help your
credit score a bit.
Payday loans -- One of the most expensive forms of borrowing doesn't get reported to credit bureaus.
loans -- Similar to payday
loans, except that the lender can repossess your car if you don't pay on time.
cards -- They're loaded
with fees and, at best, report use to alternative credit bureaus.
Rent to own -- You pay big for these programs without getting
any credit record benefits.
or other retirement loans
-- These don't show up on your credit report and may involve expensive
Store loans: yellow light
Installment loans from furniture or hardware retailers also can add
variety to your credit -- but proceed with caution. Home Depot, the
Atlanta-based chain of building supply stores, offers a Project Loan for up to
$40,000. You get six months to repay the loan interest-free. After that, you'll
be charged interest at a rate "as low as" 7.99 percent annually, according to the
Such loans come with
a caveat, says Berardi.
She recommends you pay off the loan in the allotted time before interest
Other experts are even more cautious. "For
the most part, these loans aren't worth it even if you pay everything on time,"
says Tom Joyce, vice president of marketing at the Better Business Bureau
serving Chicago and Northern Illinois.
Better to pay with a credit or debit card,
he says. He notes that credit cards usually have lower interest rates than
store loans and a credit card company is more likely than the retailer or
finance company to have your back if the furniture falls apart a month after
you buy it.
More importantly, credit bureaus look
askance at store loans, "because they make people look like they're in
financial trouble and can't pay for something themselves," Joyce says. They're
considered a last resort.
The BBB's final advice? Use your credit or
debit card to pay for big purchases. If you do succumb to temptation, read the
fine print for interest rates, prepayment penalties and other potential traps.
See related: Gearing up your credit score before a house purchase
, Don't jeopardize great credit with new credit
Published: July 26, 2013