Rules of the road to improve your credit mix
Looking to improve your credit score to get the best rate on a mortgage loan over the next year?
While responsible credit card management is the best way to improve your credit score, if you need to jump over a hurdle, you can turn to your credit mix. Having more diversity in the types of credit you use can boost your score, as long as you make your payments on time.
The biggest factors in calculating your credit score are the payment history (35%) and the amount you owe (30%), according to FICO, the agency based in San Jose, Calif., that calculates and issues FICO Credit Ratings. The length of credit history (15%), new credit (10%), and credit mix (10%) make up the rest of the pie.
While the credit mix is a small category, it can make a difference if you’re struggling to take a FICO score up a notch – from, say, 720 to 740. “We’re talking 10 to 20 points, not 100, “says Ethan Dornhelm, senior scientist at FICO.
Have a variety of successfully managed credit accounts ranging from revolving credit cards to installment loans (such as personal loans, auto loans, and mortgages) demonstrates responsibility in handling a wide variety of types of credit, says Dornhelm. “If we look at the risk patterns, we find that people with a healthy balance of using all types are at lower risk,” he says.
We have nothing, nothing Before you go looking for new credit, be aware that taking out different types of credit will not automatically increase your score. In fact, your score may temporarily drop, Dornhelm says, when the lender makes a Hard shot on your credit to determine your repayment capacity. However, hard draws are only temporary hits, as long as you proceed slowly and carefully when applying for new credit. Too many new accounts can be interpreted by a lender as a sign that you are in financial difficulty.
But making payments on time will help your score recover. For example, Dornhelm says that taking out a $ 5,000 car loan has the immediate effect of lowering a score because it’s new credit. After making five regular payments, however, your score should return to its old level and then to some.
Just make sure you can afford those payments. If you take on debt that you can’t afford, you’ll end up doing more harm than good. Paying on time is the key. “As long as you demonstrate responsible use, you will benefit,” says Dornhelm of FICO.
With that in mind, here are some good – and not so good – ways to add variety to your credit mix with installment loans. A green light means moving forward, as long as you’ve weighed the pros and cons. Yellow means be careful – there could be trouble ahead. Get away from the red lights.
Car credit: green light While you can afford to pay for a car in cash, you might want to consider paying for it over time. If your credit is good, you may be eligible for a very low interest loan that could improve your credit mix and possibly increase your credit score even further.
You can get auto loans from several different sources. Most dealerships are affiliated with finance companies that offer loans. You can also get a loan from your bank or credit union. The better your credit score, the lower the interest rate you will be offered.
If your score is less than stellar, consider using a credit union. Federal credit union interest rates are capped by law at 18% and may be more reasonable than fleet or finance company rates, says Rex Johnson, owner and founder of Lending Solutions Consulting Inc., a credit company. union consulting firm in Elgin, Ill.
Additionally, nonprofit credit unions want to help people build credit scores and are more forgiving of less than perfect credit, he says.
How long should the loan be? Let your budget guide you.
Johnson says that because your credit history counts for 35% 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 extending your loan terms just to improve your score, Johnson warns.
Personal loan: green lightPersonal loans are generally made to individuals without any collateral required. People use personal loans to consolidate credit card balances, pay tax bills, finance weddings, and a number of other expenses.
One of the most interesting things about personal loans is that they may have a lower APR than a credit card. Wells Fargo, based in San Francisco, for example, offers personal loans of $ 3,000 to $ 100,000, starting at about 7% of the APR. This compares to Average APR on credit cards of 14.96%.
Peer-to-peer loans organized by companies such as Lending Club and Prosper are an increasingly popular route to personal loans. These companies report your account activity to the credit bureaus, which means they should help you build your credit if you pay on time. You usually need a really good credit score to qualify, but the application process can be easier than going through a bank.
Student loans: green light FICO also takes student loans into account when considering your credit mix. As installment loans, student loans carry the same weight as, say, a car loan, Johnson says.
The key for student loans to build your credit score is to stay on top of payments. Ideally, this means making the required payment each 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 Assistance Project if you have payment problems. They can help you educate yourself about consolidating your student loans. “If you communicate, you’re up to date,” she says. “It’s very big.”
Store loans: yellow lightInstallment loans from furniture or hardware retailers can also add variety to your credit, but proceed with caution. The Home Depot, the Atlanta-based building supply chain, is offering a project loan of up to $ 40,000. You have six months to repay the loan without interest. After that, you will be charged interest at a rate “as low as” 7.99% per annum, according to the store’s website.
With such loans come a caveat, says Berardi. She recommends that you repay the loan within the allotted time before the interest charges start.
Other experts are even more cautious. “For the most part, these loans aren’t worth the trouble, even if you pay it all off 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 generally have lower interest rates than store loans, and that a credit card company is more likely than the retailer or finance company to back you up if the furniture falls out. pieces one month after purchase.
More importantly, the credit bureaus look askance at store loans, “because they make it look like people are in financial trouble and they can’t pay something themselves,” Joyce explains. They are considered a last resort.
The last advice from the BBB? Use your credit or debit card to pay for large purchases. If you succumb to the temptation, read the fine print for interest rates, prepayment penalties, and other potential pitfalls.