When it comes to your credit score, not all forms of debt are considered the same. Credit comes in many forms: credit cards, mortgages, auto loans, student loans, and so on. However, all forms of credit do fall within three distinct types of credit. Those are installment, revolving, and open credit.
Having multiple types of credit boosts your credit score; not having a good mix can hurt it. Here are the details on the three types of credit and how to use them to build a better credit history.
Installment credit is a loan that you borrow in one lump sum and then repay over time with fixed payments. The most common examples are auto loans, personal loans, student loans, and mortgages.
With an installment loan, your monthly payment is usually the same every month, so it’s easy to budget for the payments. You also typically have a set repayment schedule, which can help you plan ahead and pay off the debt more quickly.
With revolving credit, you can borrow money up to a set credit limit and then repay it over time. The most common form of revolving credit is a credit card, but a line of credit, such as a HELOC, also falls within this category. “Revolving” refers to the borrower’s ability to pay back all or a portion of what they borrowed and then borrow up to their limit again.
With revolving credit, your monthly payment can fluctuate based on your outstanding balance. If you only make the minimum payment each month, it will take longer to pay off the debt and you’ll end up paying more in interest.
While you’re probably familiar with both revolving and installment credit, open credit is much less common. With open credit, there usually isn’t a preset credit limit. Rather, the dollar amount available to you varies depending on your current financial status. You can borrow the full amount available to you each month as long as you pay that full amount back each month.
Since the balance is repaid monthly, interest isn’t generally a factor in open credit. However, there are often high annual fees for this type of credit, and if your monthly payment is late, you can expect an expensive late fee. Open credit is most often associated with charge cards (not to be confused with credit cards), and very good credit is required to even open this type of account.
Why You Need All Three Different Types of Credit
Having a mix of the three types of credit is the best way to build a strong credit score because it demonstrates to lenders that you can handle different types of debt responsibly. This can help you get approved for new credit and get better interest rates on loans since lenders will see you as less of a risk.
Installment credit shows lending institutions that you can make on-time, fixed monthly payments. This happens every time you make your regular auto, student, or home loan payments. Revolving credit shows that you can manage fluctuating monthly payments and make at least the minimum payment each month. Finally, using open credit responsibly demonstrates that you can manage your money well by spending within your means and keeping up with repayment.
If you don’t have all three types of credit, however, don’t panic. And don’t run out and sign up for a slew of new credit accounts, as the length of your credit history is important too, and new credit can affect your credit score. Instead, the experts at Solarity Credit Union offer the following tips to help you improve your credit score.
The Quickest Way to Build Your Credit Score
There is no single method for building up a good credit score quickly. However, there are a few things that you can do that will help:
- Make sure you pay all your bills on time. This includes credit card payments, loan payments, medical bills, utility bills, and so on. Payment history is one of the most important factors in determining your credit score, so it’s crucial to make sure that you are always paid up on time.
- Keep your credit card balances as low as you can. Your credit utilization ratio, which is the amount of credit you are using compared to your credit limit, makes up 30 percent of your credit score. So it’s important to keep your balances low in order to maintain a good score.
- Mix up the different types of credit you use. Utilize the accounts you have, and if you don’t have a variety, consider opening a new account where appropriate. Just do so with caution (see number four). Also, keep in mind that, as we said, open credit is less common and may not be available to everyone. You can, however, make the best use of installment and revolving credit instead.
- Don’t open too many new accounts at once. Every time you open a new credit account, it creates a “hard inquiry” on your credit report. This can temporarily ding your credit score. So if you are looking to open multiple new accounts, space them out over a few months instead.
- Check your credit report regularly for errors. You are entitled to one free credit report from each of the three major credit bureaus every year. So take advantage of this and check your report for any mistakes. If you find an error, dispute it with the credit bureau right away.
For more information on maintaining a robust credit score, check out Solarity Credit Union. Take advantage of their online resources and talk to an expert about making the most of your credit with a home loan or mortgage refinance.