How credit mix is calculated in FICO scores
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Dear Speaking of Credit,
I see that one of the factors evaluated in FICO scoring, under credit mix, is the "percentage of trade lines that are installment loans." Could you provide guidance on whether this is based on number of accounts or value of balances? I have one installment loan, a loan secured with a CD, and it helped my score a decent amount. Would adding a second one, a car or motorcycle loan help more? Thanks in advance -- Scott
I'm glad you're asking about the often-forgotten FICO credit scoring category, "credit mix," which is almost always mentioned last whenever the makeup of a credit score is discussed. To put this set of scoring factors in perspective, with the five FICO categories, the basic question each one asks and their relative proportions are:
- Payment history: Are you making all payments on time each month? (35 percent)
- Amounts owed (credit utilization): How much do you owe among all types of credit? (30 percent)
- Length of credit history: How long have you been using credit? (15 percent)
- New accounts: Have you taken on any new credit recently? (10 percent)
- Credit mix: What different types of credit experiences have you have had? (10 percent)
The two main types of credit included in the credit mix are the revolving (card) and installment (loan) accounts. Revolving accounts include credit cards (general purpose, retail store and gas cards alike), while installment accounts include mortgage, auto, student and personal loans (secured and unsecured).
For most consumers, it's not hard to understand why a score that predicts the likelihood you will pay all obligations on time for the foreseeable future will depend on how faithfully you have paid in the past, how much debt you currently owe and how long you've been using credit. What's not necessarily so clear is why the different types of credit experiences you've had have any bearing on how you'll pay going forward.
Credit mix enters the scoring formula because of how the different financial management behaviors required for each can impact the ability to pay on time. Whereas installment debt is the more consistent of the two types, due to fixed payment amounts each month and a set length of time to pay off a steadily dropping balance, revolving balances and payments can fluctuate from month to month, often dramatically.
To give you a couple of examples, for a non-card-holding consumer comfortably making a car and student loan payment each month, adding a credit card payment to the budget could take some getting used to, causing one of the loan payment dates to be missed. Or, for a consumer used to charging and paying on a credit card only, the addition of a mortgage payment could present cash flow problems resulting in the card payment being delayed. For reasons such as these, the scoring formula likes to see some experience successfully managing both revolving and installment types of credit.
As to your first question, the percentage in the factor,"percentage of trade lines that are installment loans," refers to the proportion of your total number of credit accounts that are installment loans, regardless of how much is owed. Of course, how much you owe matters, just not within the credit mix category.
The answer to your second question -- whether you should take out a car or motorcycle loan to help your score -- requires a little more of an explanation than the first. Keep in mind that at only 10 percent of your score, no credit mix factor is likely to have any more than a minor impact on your total score. And of course, there are always some pros and cons, score-wise.
On the pro side of adding a new loan, while there's no way to know the ideal number of installment loans sought by the scoring formula, according to the score factor mentioned in your first question it appears that adding one more loan could add a few points to your score -- at least in the longer run -- that should last as long as both loans remain open.
I say "longer run" because, on the con side, the addition of any new account can be expected to initially lower your score by reducing your "average age of accounts" with the addition of a new trade line and at least one hard inquiry to your credit report.
Back to the pro side, the benefit to your credit mix from adding a new loan should outlive the negative impacts that should diminish within about six months to a year. Additionally, if your existing personal loan terminates before the proposed vehicle loan is paid off, having at least one open installment loan remaining on your credit report should be better for your score than none.
Based on the above considerations, here are some general tips for raising and/or protecting your score:
- Unless you absolutely need that vehicle and must finance it, pay off any credit card balances before taking on any new loan payments.
- Because any positive impact from improving your credit mix is not likely to be significant, base the new loan decision more on your need for that vehicle, along with quality, price and financing terms, rather than solely on your credit score.
- If you plan to apply for a mortgage within the next year, avoid opening new accounts of any kind.
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