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When it comes to your credit score, not all debt is treated equally.
Credit accounts come in many forms: credit cards, mortgages, auto loans, and student loans, to name a few. But did you know all of them can be classified into three distinct types of credit? Lenders look for evidence of each of these credit types in your credit report as proof you can manage various types of debt responsibly.
Having different forms of credit can boost your credit score — and lacking a good mix can hurt it. Here are differences between the three types of credit and how to use each to build a better credit score.
What Are the Different Types of Credit?
Your credit mix is one of the smallest factors involved in calculating your credit score, making up 10% of the equation. But if you’re trying to boost your score, it pays to look at each factor closely.
There are three main types of credit: installment credit, revolving credit, and open credit. Each of these is borrowed and repaid with a different structure.
Installment credit is a type of loan in which you borrow one lump sum and agree to repay it in regular fixed payments, or installments, over a certain amount of time. You’re also charged interest, so your repayment amount is greater than the amount you originally borrowed. Once an installment credit loan is paid off in its entirety, the account is considered closed.
Examples of installment credit accounts:
- Auto loan
- Personal loan
- Student loan
Unlike installment credit, revolving credit accounts allow you to repeatedly borrow and repay amounts from a single line of credit up to a maximum limit. You’re in control over how much you borrow (and ultimately need to pay back).
Credit cards are the most popular type of revolving credit. For example, if you have a credit card with a $6,000 limit and the balance is $2,000, you can still borrow up to $4,000 more. Make a payment of $1,000, and you now have $5,000 to spend again. Interest is charged on any balance remaining after your statement’s due date, so it’s possible to avoid ever paying a dime of interest if you pay your balance in full each month. As long as you make all your payments on time, the account will remain open indefinitely until you choose to close it.
Examples of revolving credit accounts:
- Bank credit cards
- Retail credit cards
- HELOC (home equity line of credit)
Open credit is unique in that monthly payments vary, and balances are due in full at the end of each billing cycle. Your electricity bill is a great example of open credit; the amount due depends on how much electricity you used that month. You’re expected to pay the entire bill within a certain number of days after receiving it.
Examples of open credit accounts:
- Cell phone
Less is more when it comes to establishing credit mix. While it’s good to show responsible use of different account types, you also need to weigh this benefit against the penalties for having too many accounts, which could easily harm your credit score.
How the Different Types of Credit Affect Your Score
Having different types of credit is an important part of your credit score as it shows lenders you can manage various types of debt responsibly. However, it’s not always clear how many accounts you need from each credit type in order to demonstrate the right mix.
“Consumers of any age and just about any income level can build their credit to a level most lenders consider ‘good’ with just two or three accounts,” such as credit card, car loan, or student loan, says Todd Christensen, education manager at Money Fit by DRS, a nonprofit debt relief organization. According to Christensen, results can come fairly quickly — “within a year or two so long as they make their payments on time, keep their card balances at $0, and pay down their installment loan balances as quickly as they can.”
The Bottom Line
Identifying the three types of credit is a skill that can help you plan your financial future better. Now that you know how the different types of credit work, take a look at your credit report and see if you can correctly identify each account type. You might be surprised to find you already have a more well-balanced credit mix than you originally thought.