A credit score is calculated taking several factors into consideration; a statistical account of your creditworthiness & credit history. Borrowers are required to have a credit score of 700 or above to have the freedom to avail loans & apply for credit cards to meet their financial requirements.
Credit mix is basically the types of accounts that build your financial history and as a result, your credit score. Credit types that can be part of a credit mix include credit cards, mortgages, loans of any kind (student, personal, car or home). It constitutes 10% of the credit history as it indicates the different kinds of credit an individual can handle & repay back.
There are a total of 5 factors that affect your credit score:
1. Payment history: 35%
2. Amount of debt owed: 30%
3. Age of the credit history: 15%
4. New lines of credit: 10%
5. Credit mix: 10%
Different types of Credit you can have:
Credit is available for borrowers in 3 main categories:
– Revolving credit: These are credit lines with a monthly credit limit. It gets renewed as soon as you clear the previous dues. A borrower is allowed to utilize as much of the credit limit as per requirement in one go or in multiple transactions. It includes credit cards & home equity lines of credit, not very common in India.
– Installment credit: These lines of credit have a set installment to be paid across a predetermined time period. The loan payments are listed in an amortization schedule. As the borrower goes on to pay the installments one-by-one, it keeps reducing from the amortization schedule in the loan agreement. This line of credit includes student loans, home loans, auto loans, mortgages, etc.
– Open credit: A credit line that is preferred by a few. Open credit lets the borrower use a fixed amount which should be paid back in full every month it is used. This type of credit is usually associated with charge cards, and not credit cards.
If it is good, should you overdo it?
Diversity is encouraged in the world of credit for the borrower’s benefit, but it is not a hard & fast rule. You can have even one line of credit & ensure that you make timely payments to clear it. The fact that it constitutes only one out of 5 parts of your credit report can help you remain at ease but it will help you only as long as you are able to repay it on time.
Having a mix of credit basically clarifies a borrower’s image in front of the lender. It demonstrates the ability of the borrower to pay back different kinds of credit lines, indicating that you are responsible. The potential lenders will view in a brighter light & see you as less of a risk.
How can you apply this to your credit score?
Building a good credit score doesn’t limit to only picking up different lines of credit, but it also includes your timely repayments & other historical data. A major part of it is the credit utilization ratio!
Since revolving credit is one line that most borrowers deal with on a day-to-day basis, it is vital to keep an eye on your credit cards & home equity lines of credit. Another reason to pay close attention to it is that it determines your credit utilization, which constitutes 30% of your credit score.
Repay your credit card dues each month & ensure that you keep a low balance on it to keep your credit utilization low, as a result of which your credit score will strengthen. Credit card limits keep increasing gradually and often land borrowers in debt. So make sure you don’t fall in that trap & maintain good credit utilization.